Limit Stop
A limit stop is a stop-loss order that triggers at a set price, ensuring trades are executed only within a specified price range.
What Is a Limit Stop?
A limit stop is a type of stop-loss order used in trading to control risk by triggering an order when a security reaches a specific price limit. Unlike a traditional stop order, which becomes a market order once triggered, a limit stop only executes if the trade can be completed at the set limit price or better. This gives traders more control over the price at which their order is filled.
How Does a Limit Stop Work?
A limit stop order requires two key prices: the stop price and the limit price. When the stop price is reached, the order turns into a limit order rather than a market order. The trade will only be executed at the limit price or better. For example, if you own a stock trading at $50, you might set a stop price at $48 and a limit price at $47.50. If the price drops to $48, your order is triggered, but it will only execute if the stock can be sold at $47.50 or higher.
Why Are Limit Stops Important for Investors?
Limit stops help investors manage risk and protect profits, especially in volatile markets. They allow for precise control over trade execution, reducing the chance of selling or buying at an unfavourable price during rapid market moves. However, there is a risk that the order may not be filled if the price moves past the limit too quickly or if there isn’t enough liquidity at the limit price.
Example: Limit Stop in Practice
Suppose an investor holds shares of a company trading at $100. To limit potential losses, they set a stop price at $95 and a limit price at $94. If the share price falls to $95, the limit stop order is triggered. The shares will only be sold if they can be sold at $94 or better. If the price drops below $94 too quickly, the order may not be executed, and the investor still holds the shares.
When Should You Use a Limit Stop?
A limit stop is most useful when you want to manage risk in fast-moving or volatile markets and need certainty about the minimum or maximum price at which you are willing to trade. It is especially valuable for traders who cannot monitor the market constantly or want to automate their risk management with clear price boundaries.
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