Why use a stop-limit order instead of a limit order?

Question

"A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher." - Investopedia

"A stop-limit order will be executed at a specified price, or better, after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy or sell at the limit price or better." - Investopedia

If the stop-limit order simply becomes a limit order at the stop price, what is the point of making a stop-limit order if you can simply make a limit order? Both definitions appear to be the same thing to me. Stop-limit orders have a given "stop" price while limit orders have "a specified price," and both sell or buy at this price point. I suppose the difference could be the fact that before the stop-limit order is executed, it is a different type of order, but I don't see how there's a functional difference.

Answer 1

Stop orders wait until a particular (adverse) condition is met before turning into a limit order.

On the sell side:

• If the price is currently $40 and you submit a limit order to sell at $36, it will immediately execute at $40 because this is even better than $36.
• If the price is currently $40 and you submit a stop-limit order to sell at $36, it will wait until the price falls to $36 before selling.

On the buy side:

• If the price is currently $40 and you submit a limit order to buy at $45, it will immediately execute at $40 because this is even better than $45.
• If the price is currently $40 and you submit a stop-limit order to buy at $45, it will wait until the price rises to $45 before buying.

Generically you can think of a stop order as the opposite of a limit order. The limit order executes when prices are good for you while a stop order executes (turns into a market or limit order) when prices are bad for you. You use it to limit your losses if you think prices are going to get even worse.

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As Keith points out, a stop limit order may also have a different limit and stop price. In this case the stop converts to a limit order when a bad price is reached (the stop price), and the limit order then executes when the price improves enough to reach the limit price.

Answer 2

The investopedia article gives a decent example:

For example, assume that ABC Inc. is trading at $40 and an investor wants to buy the stock once it begins to show some serious upward momentum. The investor has put in a stop-limit order to buy with the stop price at $45 and the limit price at $46. If the price of ABC Inc. moves above $45 stop price, the order is activated and turns into a limit order. As long as the order can be filled under $46, which is the limit price, the trade will be filled. If the stock gaps above $46, the order will not be filled.

If instead a limit buy at $46 were entered while the stock was at $40, then the stock would likely be bought for $40, since the limit order means "buy at any price less than $46". If just a stop order were placed, then the stock could be bought for more than $46, since the stop means "buy at any price as soon as the stock goes higher then $46".

Selling is the same, but the directions are opposite. Suppose the stock in the example above has a current price of $46 and you put in a stop-limit sell with a stop price of $41 and a limit of $40. When the stock drops below $41, a limit sell is placed that will sell your stock for at least $40 if possible. If the stock drops below $40 before your limit order can be filled (e.g. because there are many other sellers front-running you), then your limit order is not filled until the price comes back to $40.

If instead you had just a limit sell, since the price is already above $40 you'd likely get it filled immediately somewhere near $46. A "normal" limit sell is placed above the current price, since a limit sell is "sell the stock at any price above X". With a stop-limit sell, both prices are generally below current market ("sell if the stock drops below X, but don't sell for less than Y")