Is a stop limit the same as a stop order?
A stop limit is typically used when you are trading during a volatile market and want to target a specific price as closely as possible. When placing a market order, the price you pay is the best price available in the market at the time the order is executed. With a market order, you cannot be sure of the price you'll get, especially for more thinly traded securities or larger orders that may need to be handled in multiple transactions.
A stop order instructs your broker to buy a stock only when it is selling at or below a specified price or if you are selling, when it is at or above a certain price. Once the stop is triggered – in other words, once your specified price is reached – your order becomes a market order and is executed at the market price. However, if markets are volatile or the security is illiquid, the market price can change between the time the stop is triggered and when the order is fully executed. If you are buying a stock and that price is lower, you benefit, but if the execution price is higher, you may pay more than you expected. For example, if you're buying a thinly traded security and your order isn't fully executed before the end of the trading day, you could run the risk of the market opening up strongly the next day – a phenomenon sometimes known as "gapping up" – potentially taking the price of your targeted stock with it. Conversely, if you are selling a stock and the price moves lower before the trade is fully executed, you might make less from the sale than you intended.
A stop-limit order puts a limit on the price you are willing to pay for your purchase or accept if you are selling. It mandates that a purchase be executed at a specific price or better; that price can be different from the stop level that triggers a trade, and increases the odds of the transaction meeting your expectations. If you are selling, a stop-limit order also can be used to set a minimum price for the sale. Stop limits are typically good for a specific time frame, such as a day, a week or a month.
Why wouldn't everyone use a stop-limit order with every trade? Because they typically cost more to use than market orders. As a result, a stop limit probably makes the most sense for large orders in volatile markets, when a difference of even a penny or two per share can mount up.
Can a stop-loss order really protect me from losses?
As the name implies, stop-loss orders are a way to help you manage the amount of loss you can suffer on a single holding. Also known as a stop order or stop-market order, a stop-loss order sets a level at which your broker is instructed to sell all or part of a particular position once the stop-loss point is reached.
With a stop-loss, you can specify a share price below which you do not want to hold a stock. Once the bid price hits that level, the position would be sold automatically at the market price. You also can employ what is known as a trailing stop-loss to adjust the stop upward if a security's price rises. The stop might be calculated as a percentage or a dollar amount relative to the bid price (for example, a loss of 10% or a $2 per share drop). If the stock's price moves higher, your stop level also rises. That can help protect a portion of your paper profits while potentially allowing you to participate in any further upward appreciation. If the price falls, the holding simply moves closer to the level at which it will be sold.
In addition to helping you minimize losses you cannot handle, stop-loss orders are one way to remove emotion from your investment decision-making. They also can be especially useful if you are anxious about volatile markets at a time when you know you'll be traveling in remote areas and unable to monitor your accounts easily.
However, under certain circumstances, stop-loss orders can be a mixed blessing. Just because you have specified a certain stop-loss level does not mean your trade will be executed at that exact price; once your specified level is triggered, the trade will be executed at a market price. If markets are extremely volatile or if a security is thinly traded, you might lose more than the amount you expected.
For example, during the 2010 "flash crash," when prices plummeted and markets were temporarily illiquid, some stock positions were sold at prices well below the stop loss. Some of those trades were subsequently voided, but it is still a good idea not to take the protection of stop-loss orders for granted, and to know that there can be a gap between expectations and execution.