Equity limit and stop orders are particularly handy when you can’t watch the market all day but don’t want to miss any important market action. The basic difference is limit orders help you maximize your trading returns, while stop orders help you protect your capital from large losses.
Limit orders can be either buy or sell. A limit order sets the maximum price where you'll buy or the minimum price where you'll sell a stock. For example, let's say you want to buy 100 shares of XYZ. It is trading at $27.35, but you’d like to get a better price. You enter an order to buy 100 shares of XYZ at a $27 limit. If XYZ drops to $27, the order will be executed at that or a lower price. If, on the other hand, you want to sell your XYZ shares and think you can get a higher price, you could enter a limit order to sell at $28. If XYZ rises to $28, your order will be filled at that or higher price.
Stop orders can also be either buy or sell. A stop order is a threshold, a trigger activated under specific market conditions. For example, if stock XYZ has been trading between $26 and $28 in the last few months, you might think it will "break out" in trading lingo if it goes above $28. You could enter an order to buy at $28.10 stop. If XYZ ever does trade at that price, your order will be “triggered,” or executed at the next available market price. Of course, the stock could go up, or fall back down. In this case, you could protect yourself from a big fall with a stop order at $25.29. If XYZ continues to rise after you bought it, you'll make money. If it falls, you never lose more than $25.29.
Limit and stop orders can be day or GTC (good-till-cancelled) trades. A day order expires at the end of the trading day if not executed, while a GTC is valid for up to 60 days. A day order makes sense if you're the type who checks stocks daily. A GTC order gives you peace of mind for up to 60 days. You can go on a business trip or vacation knowing your stock positions are in good shape.
Getting More Sophisticated
As different as limit and stop orders are, they can be combined in sophisticated trading strategies. For example, if you want to catch XYZ as soon as it trades at $28.10, but don't want to overpay, you may enter a buy order $28.10 stop and $29 limit. If your stop is triggered, XYZ will be bought only if it is available at $29 or less.
Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.