Stop Order - Types of Stop Orders: Buy-Stop, Stop-Loss, Stop Market/Stop-Limit - Example
Here we give the definition of a stop order and illustrate how it works. The article also describes the different types of stop orders and advises on when to use which.
What is a Stop Order?
A stop order is a request to buy or sell a particular asset on an exchange with an activation point in terms of price established. Upon the asset arriving at a predetermined price point, a stop order executes the trade at a market (stop-market) or limit (stop-limit) price.
While limit orders specify an exact price for which (or better) they will be able to complete a trade, a stop order’s predetermined price point serves to trigger its execution as a market or limit order.
There are several variations of a stop order designed to suit different trading needs. They include buy-stop orders, sell-stop (stop-loss) orders, stop-market orders and stop-limit orders.
How a Stop Order Works
A stop order is executed after the traded cryptocurrency, security or fiat currency reaches a specific price. They do not appear in the order book until triggered by the asset surpassing the predetermined valuation.
Stop orders are commonly used by investors who are looking to prevent losses or lock in profits in the face of their possible future inability to monitor the prices “live” or when trading markets with high volatility.
To place a stop order an investor determines a price level at which the trade will be activated. For stop-limit orders a limit price in addition to the stop price should be specified.
Pros and Cons of Stop Orders
- Allow price control. Stop orders are activated only after their underlying asset gets to a prespecified stop price. Stop-limit orders are additionally guided by a limit price.
- Execute trades automatically. Stop orders provide investors with tools to manage risk and gain profits without having to manually monitor the market.
- Planned trades. Stop orders are useful when trading with a specific strategy.
- No execution guarantee. Same as limit orders, stop orders may never be filled if the underlying asset never reaches a predetermined price. For stop-limit orders two specified price levels should be met: the stop price and the limit price.
- Partial order fill. In case there is not enough liquidity on an exchange, a stop order may be filled in parts, which will result in additional trading fees.
Stop Order Scenario
Bull Markets
A bull market refers to financial market conditions under which asset prices rise for a sustained period of time. As most markets rise and fall continuously, the term “bull market” is reserved for prolonged time intervals in which prices are in an uptrend.
To take advantage of a bull market investors try to buy assets at the beginning of the uptrend and sell at the peak. Technical analysis techniques can be used to roughly predict when an uptrend or downtrend might start or finish.
In a bull market a stop-loss order allows traders to enter a position at a level low enough to profit from the future uptrend, while a take-profit order allows them to sell as the asset reaches a price peak.
Bear Markets
A bear market is a financial market state in which asset prices experience a consistent downtrend. In a bear market a large portion of the assets of a certain type steadily decrease in value.
Stop-loss orders sell positions in bear markets to prevent losses, while take-profit triggers buys to get the lowest possible price.
Stop-Limit Order Example
Let us suppose Bitcoin (BTC) is currently trading at $39,000 per unit and a trader is looking to buy BTC as it starts to enter an uptrend. To avoid paying a high market rate as BTC quickly rises, the trader will need to place a buy stop-limit order and establish a limit price. Through use of technical analysis, the trader determines the bullish trend might start as BTC breaks above $41,000. A buy stop-limit order with a stop price at $41,000 and a limit price at $41,500 can potentially allow the trader to buy BTC at the beginning of the uptrend. As soon as BTC gets to $41,000 a limit order with a $41,500 limit price will be placed. The trader will only buy BTC for $41,500 or less. However, if the price rises above $41,000 too quickly, the order will not be completed at all.
Types of Stop Order
Buy-Stop
A buy stop order, also known as a take-profit, is most commonly utilized by traders to maximize gains. A buy-stop order to sell serves to get the most out of the asset's bullish movement, while a buy-stop order to buy is placed in the face of bearish trajectory. A buy-stop order to buy is more frequently used than a buy-stop order to sell.
Stop-Loss
As the name suggests a stop-loss order is generally employed by traders to minimize possible losses. The most commonly used version of the stop-loss order, the stop-loss order to sell, is set to prevent the losses in an underlying asset downtrend. A stop-loss order to buy can be used when the market is bullish.
Stop Market vs. Stop-Limit
Although stop-market and stop-limit orders are built differently, they both pursue the goal of risk prevention when trading volatile markets.
A stop-limit order activates a limit order that buys or sells an asset at a specified price or better after the stop price is reached. Upon placing a stop-limit order two price levels are generally specified: the price at which the order enters the market and the one indicating when to execute the order.
Filled at the next available market rate after surpassing the stop price, stop-market orders cannot protect investors from particularly dramatic price drops on fast-moving markets. For instance, in a stop-loss market order to sell, the price at which the market order will be filled can be significantly lower than the stop price. With stop-limit orders a trader can specify the lowest or the highest price they are prepared to accept while stop-market orders execute trades at the next available market price once the stop price is reached.
Stop orders FAQs
What is an example of a sell stop order?
Let us say a sell stop-limit order with a stop price set at 10 USD has a limit price of 8 USD. It will turn into an active limit order when the underlying asset price reaches 10 USD. This order can only be executed at a price of 8 USD or better.
What triggers a stop order?
A stop order has a pre-established stop price at which a market or a limit order enters an order book. A market order buys or sells an asset at the next available price after it reaches the stop price, while a limit order holds out for a specified limit price or better.
What is a stop-limit order?
A stop-limit order is an order that combines features of a stop order and a limit order. A stop-limit order places an order to buy or sell an underlying asset for a limit price or better once the predetermined stop price is reached.
