How do I use Limit Orders? Stop Orders?
(Or: "How do I tell the strategy to buy/sell when X goes above/below....")
|We probably get more angry and frustrated questions about Limit and Stop orders than any other subject.
First, some background. The terms "Limit Order" and "Stop Order" have been used by brokers and traders for over one hundred years. Please do not get angry at Collective2 for "making up" strange terminology.
Most people who have previously traded with real brokers know about limits and stops. The exception seems to be Forex traders, since Forex trading platforms try to 'hide' these terms from their users, to keep trading simple.
In any case, here's how the terms work, and what they mean.
When you place a Limit Order, you are telling your broker to demand a certain price or better.
When you place a Stop Order, you are telling your broker to wait until the market becomes less favorable than your price.
Please do not confuse a "stop order" with a "stop loss" -- these terms are related, but not identical. More on this soon.
First, let's look at four examples. Each example assumes you are interested in trading IBM, and that IBM is currently trading at around $80 per share.
Notice in these first two examples that we use Limit to mean "this price or better" and Stop to mean "this price or worse." How do we determine what is "better" and what is "worse?" When we buy, we want prices to be as low as they can be. When we sell, we want prices to be as high as they can be.
Let's look at two more examples to demonstrate this further:
Notice how when we are selling, unfavorable prices mean a price below our target. In contrast, when buying, unfavorable means above our target.
The key to remember is:
Limit = this price or better
Stop = this price or worse
What is the difference between a "stop loss" and a "stop order"?
These terms are related, but -- if we want to be very exact -- they do not mean the same thing. A "stop loss" is an order you place at a broker which is designed to limit your loss. It is an exit order, or, in Collective2-speak, it is a "to close" order. You might buy IBM when it is at approximately $80 dollars, and place a stop loss order to Sell To Close IBM at stop $60 -- in other words, to sell IBM if the stock ever goes below $60 dollars. A stop loss order is a "stop" order. Not all stop orders, however, are "stop losses."
Remember that a "stop order" can be used to enter a trade, too. For example, if IBM is trading at $80 dollars, and you want to go long when it reaches $100, you would enter a BUY @ STOP $100. Conversely, once you bought the stock at $100, you might decide that you will sell it if it ever goes below $60. This would be a stop-loss order, and to place it at Collective2, you would issue: Sell To Close @ Stop 60.
To summarize: A "stop loss" order is a special kind of stop order. While you can use a "stop" order to either enter or exit a trade, a "stop loss" is a special kind of stop order which is designed to exit a trade at a pre-determined loss level.