Monday, July 4, 2011

Understanding Stop Limit Buy Orders

For momentum trading methods such as CANSLIM, it often becomes imperative to use a buy stop order in order to get into a stock at the correct time. I place my orders through Fidelity and was confused with their variant of buy stop orders, known as the stop limit orders for the longest time until I found the following explanation from Investopedia:

What Does Stop-Limit Order Mean?
An order placed with a broker that combines the features of stop order with those of a limit order. 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 explains Stop-Limit Order
The primary benefit of a stop-limit order is that the trader has precise control over when the order should be filled. The downside, as with all limit orders, is that the trade is not guaranteed to be executed if the stock/commodity does not reach the stop price.

A stop order is an order that becomes executable once a set price has been reached and is then filled at the current market price. A limit order is one that is at a certain price or better. By combining the two orders, the investor has much greater precision in executing the trade. Because a stop order is filled at the market price after the stop price has been hit, it's possible that you could get a really bad fill in fast-moving markets.

For example, let's 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 (the limit price), then the trade will be filled. If the stock gaps above $46, the order will not be filled.

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