As the name implies, a stop-limit order combines both a limit order and a stop order. This order type is available on the MT5 platform and lets the trader set two prices: one to activate the trade and another that dictates the worst price at which the trader wants to buy or sell. If the asset price reaches the stop price level, this order is activated as a limit order.
A stop order provides the trader with more control over the price at which the trade is executed, but there is no guarantee that the trader will get triggered at that price.
The Mechanism of a Stop-Limit Order
Two price levels are used to set a stop-limit order.
1. Stop price — this is the price that triggers the order.
2. Limit price — this is the minimum acceptable price at which the trader is willing to buy or sell after the order/trade has been activated.
Example: Short Order
Suppose you want to short a stock CFD at a price of $100, but you want to protect your trade against falling prices without having to sell at a price that is substantially lower. You could set the trade as follows:
- Stop (trigger) price: $95
- Limit (boundary) price: $93
If the stock drops from $100 to $95, the stop-limit order activates and becomes a Sell Limit order. In effect, the brokerage platform interprets this stop-limit order as an instruction to activate the trade once the stock’s price drops to $95, but not below the $93 boundary. Any sudden slippage or risk event that sends prices sharply below $93 can render the order unfulfilled.
Uses of Stop-Limit Orders
The following are the reasons for using a stop-limit order.
1. Control the execution price of a trade
By setting a maximum buy price or minimum sell price, the trader can better control trade execution and protect against events such as slippage.
2. Manage slippage
Conventional market or stop orders are prone to slippage, especially during high-risk market events that create rapid price movements. By setting price boundaries, it becomes easier to find counterparties willing to take the opposite side of the trade
3. Automate trading decisions
As with other pending order types, a stop-limit order lets you set a trade entry in advance. That way, you don’t need to monitor the asset’s price continuously, staring at screens all day.
4. Implement technical strategies
Stop-limit orders also help you benefit from trading strategies that require price confirmation before execution. For instance, if you are trading a chart pattern or a support-resistance strategy that relies on a breakout move, a stop-limit order creates a better system for working with the price moves that accompany strategy confirmations. These technical strategies include breakouts, technical invalidations, and trend continuations.
Pitfall of Stop-Limit Orders
While a stop-limit order can help control trade entries, it has no impact on trade exits, especially if the market gaps to a price above the stop-limit buy or below the stop-limit sell points.
Another Stop-Limit Order Example
Imagine a situation where the trader wants to trade an opportunity on Bitcoin when the price is at $80,000. The trader identifies a technical invalidation at $74,000, and decides to use a Stop-Limit Buy order to effect the trade.
Stop price: $74,000
Limit price: $73,000
What are the potential scenarios in an orderly market decline vs a choppy market that sees a sudden crash?
Scenario 1: Orderly Decline where BTC falls below $74,000 and trades at $73,500–$73,900.
The stop-limit order will activate as the market price stays above the $73,000 limit boundary.
Scenario 2: Sudden crash where BTC falls below $74,000 and trades at $70,000
If BTC drops directly from $74,000 to $70,000 (and such steep drops have happened with BTC in the past), the stop-limit order will trigger. However, the broker can’t trigger the limit order because the price crashed below the $73,000 order boundary. This execution risk exposes the trader to further downside.
Therefore, a trader must consider several factors before using a stop-limit order. Some of these are:
- The state of market liquidity and trading volumes
- market volatility
- Potential for overnight or weekend gaps
- High-impact news events
- Any broker order execution rules