Stop-loss or stop-limit order: - Which order to use?
Stop-limit orders can guarantee a price limit, but the trade may not be executed. This can saddle the investor with a substantial loss in a fast market if the limit price does not get filled before the market price drops below that amount. If bad news comes out about a company and the limit price is only $1 or $2 below the stop-loss price, then the investor must hold onto the stock for an indeterminate period before the share price rises again. Both types of orders can be entered as either day or good-until-cancelled (GTC) orders.
Choosing which type of order to use essentially boils down to deciding which type of risk is better to take. The first step to using either type of order correctly is to carefully assess how the stock is trading. If the stock is volatile with substantial price movement, then a stop-limit order may be more effective because of its price guarantee. If the trade doesn't execute, then the investor may only have to wait a short time for the price to rise again. A stop-loss order would be appropriate if, for example, bad news comes out about a company that casts doubt upon its long-term future. In this case, the stock price may not return to its current level for months or years, if it ever does, and investors would therefore be wise to cut their losses and take the market price on the sale. A stop-limit order may yield a considerably larger loss if it does not execute.
Another important factor to consider when placing either type of order is where to set the stop and limit prices. Technical analysis can be a useful tool here, and stop-loss prices are often placed at levels of technical support or resistance. Investors who place stop-loss orders on stocks that are steadily climbing should take care to give the stock a little room to fall back. If they set their stop price too close to the current market price, they may get stopped out due to a relatively small retracement in price and miss out when the price starts to rise again.
Stop-loss and stop-limit orders can provide different types of protection for both long and short investors. Stop-loss orders guarantee execution, while stop-limit orders guarantee price.
Mark Cussen can be contacted via this link: Mark P. Cussen