Many stock trades are transacted at market prices – that is, a stock is bought or sold at whatever price is quoted at the time of the trade. Some traders, however, prefer to buy and sell stocks at a price they specify. Limit, stop and stop limit buy orders allow traders to do that, although each order is used in different situations and for different reasons.
Buy stock using a limit buy order if you want to purchase the stock below the current market price. For instance, a stock is currently quoted at $25.46 but in the past week it has traded as high as $26.78 and as low as $22.12. If you feel you can get the stock at a lower price, you could enter a limit buy order, in effect stipulating the maximum price you are willing to pay for the stock. A limit order is always entered below the current market price. For example, you could enter a limit buy at $23 and your order would be executed if the stock ever reaches that price.
Use a stop buy order to buy new breakouts. A breakout occurs when a stock that has been trading in a tight price range (called a base) breaks out of that range on strong volume. A stop buy order is always entered above the current market price. For example, a stock you are interested in has been trading between $22 and $27 for some time; each time it approached $27, it sold off. You feel that if it trades above $27, it would start a new leg up that could carry the price into the mid-$30s, so you place a stop buy at $27.10. If the stock trades at $27.10, the stop buy order becomes a market order and is executed at the next available price.
Choose a day or Good ‘Till Canceled (GTC) order when placing limit or stop buy orders, depending on your timeframe and needs. A day limit or stop buy order expires at the end of the trading day if not filled. A GTC order is valid for up to 60 days.
Use a stop limit buy order if you want to buy a breakout but do not want to overpay for it. If you place a GTC stop buy order and the stock gaps up on unexpected news, that is, opens at a much higher price than it closed the day before, the order will be filled at that price. The stock may open at the high of the day and slide towards the close, subjecting you to a quick loss. For example, you place a GTC stop buy at $27.10; the stock closes at $26.25 the day before; some unexpected good news is released after market close and the next day the stock opens at $33 with no trades in between. Your order is filled at $33.56 but the stock slides to $29.84 by the close. To minimize the risk of overpaying, you could place a stop limit buy order, for example, buy stop $27.10, limit $29, which means that the stock should be bought if it trades at or above $27.10, but only if its price is below $29, protecting you from paying too much in a gap up. If the stock opens at $33, your stop 27.10 limit 29 buy won’t be filled.
- “PassTrak Series 7: General Securities Representative License Exam”; Dearborn Financial Services; 2003