Limit Orders and Stop Orders
To understand limit orders and stop orders, let’s first define what is a market order. A market order tells someone’s broker to immediately buy or sell a security at the current price of the market. Therefore, a market order gives no control over the fill price. In essence, a market order buys at the high end of the spread (the difference between the bid and ask prices of a security), and sells at its lower end. To gain some control back over the price, investors and traders should consider limit and stop orders.
A limit order is a type of order that ensures that a security is bought or sold at a specified price or better. For buy limit orders, the order will be executed only at the limit price or a better one, whereas for sell limit orders, the order will be executed only at the limit price or a higher one. However, if the price never reaches the level specified by the limit order, no transaction will happen. In a nutshell, a limit order defines the maximum or minimum price at which someone is willing to buy or sell a particular security.
A stop order represents an order to buy or sell a security when its price goes above a certain threshold. A stop order ensures greater chances of achieving certain entry or exit points, and it helps investors and traders to limit their loss, or to lock in a profit. After the price of the security surpasses the predefined entry/exit point, the stop order becomes a market order and executes immediately.
Stop orders are mostly used when investors are not able to monitor their portfolio over a certain period of time (eg: holiday), or in volatile markets.