Stop-Limit Order Definition in Forex

Defining Stop-Limit Order

A stop-limit order is a trading tool or strategy that allows traders to boost revenue while reducing risks. It is a combination of two types of orders. These are the limit order and stop order. It can also be linked to a different type of order known as stop-on-quote order. 

Listed below are some key factors of stop-limit orders that you should take note of.

  • A stop-limit order is a form of controlled trade that involves the combination of a stop order and a limit order to lessen your losses or risk. 
  • A stop-limit order is utilized to minimize or reduce an investor’s losses by securing their gains.
  • Traders that utilize the stop-limit order tool have complete control over when their trade will be executed. But this does not mean that all their orders will be executed. 
  • A stop-limit order trade is only placed when the price specified by the client has been reached and will be closed at the current market value. 

How Does a Stop-Limit Order Work? 

Although it sounds pretty straightforward, you have to take some time to understand how a stop-limit order works before you use this tool or strategy. To set up a stop-limit order, you will have to set the price of the limit and the stop. You will also be asked to set up the time for when the system should execute your stop-limit order.

The limit price you choose is the price limitation for the trade, and it must be fulfilled at that exact value or higher. The stop price, on the other hand, opens up the trade, and it is dependent on the value at which the asset was last traded.

When a forex trader sets a stop-limit order, it is broadcast to the public exchange and recorded into the order book. The order will be marked as “active” until it is either fulfilled, manually canceled, or expires. When you place a stop-limit order, you are required to specify whether the order is for the current market trading session or a future trading session.

If you set your stop-limit order to be valid for one day only, your order will automatically be canceled if it is not implemented before the market session closes. However, you also have the option to set your order as GTC or Good Til Cancelled. This indicates that your order will remain valid until it is triggered or closed in subsequent trading times.

Keep in mind that a stop-limit order also strictly follows the operating hours of the forex market. The forex market is typically open 24 hours a day except during weekends and market holidays. 

Limit Order

A limit order is placed only when the trader is ready to set up a new trade or close an existing one at a specific price. Only if the market trades at a greater price or the price indicated by the trader will the order be filled.

A limit order is placed only when the trader is ready to set up a new trade or close an existing one at a specific price. Only if the market trades at a greater price or the price indicated by the trader will the order be filled. 

A limit-buy order tells the market to acquire the specific forex pair at the current market price until it reaches or falls below the investor’s specified price. That value has to be less than the market’s minimum price. A limit-sell order tells the market to liquidate the currency pair at the original or higher market price once the market exceeds the specified price set by the trader. That cost must be higher than the current market value.

The most common scenario where traders use a limit order is when they opt to fade breakouts when entering a trade or to open a position. When a trader decides to fade a breakout, they are not expecting the forex pair’s price to go over a specific support level. The trader predicts that the forex pair’s price will either bounce off the support level or fall off. 

For example, if a trader wants to invest in a certain forex pair, they will have to study the movement and try to predict its movement. After some time, the trader decides that the price will not break through the resistance barrier. Because of this, they decide to open a short position for that specific currency pair as soon as the price gets close to the resistance level. 

The trader then opens a limit-sell order and sets the pips just below the resistance level. Their trade or short position will then be fulfilled as soon as the forex pair’s price goes up to the set value or goes beyond that. 

Stop Order

A stop order is an order that would only become a market order if a specific price is achieved. It can be used to enter a new position or to exit an existing one. A buy-stop order advises you to buy a currency pair at market price anytime it hits your specified price or above. The purchase price must be greater than the opening market price. A sell stop order advises you to sell a currency pair once it reaches a predetermined price or goes lower than that.

Traders commonly use stop orders to enter a market while trading breakouts. Assume, for example, that the USD/JPY forex pair is racing towards an upward breakpoint and that, based on your analysis, you are confident that it will continue to advance until it crosses that level. To reap the benefits of this, place a stop-buy order just several pips above the resistance level. After that, all you have to do is sit back and wait for the possible upward breakout.

Your long position will be opened if the value reaches or surpasses the price you specified. You may also use an entry stop order if you want to trade a downward breakthrough. You should set up a stop-sell order just several pips underneath the support line to begin a short trade if the price hits or falls below the indicated price.

A stop order is also typically used to protect a trader’s gains. When you turn a profit from a winning trade, you may alter your stop-loss order to protect a percentage of your profit.

If you have a highly successful long position, you may move your stop-sell order from the losing domain to the profit zone to protect yourself from losses if your trade does not hit your profit objective and the market moves against you.

Alternately, if you have a really profitable short position, you may move your stop-buy order from the loss zone to the profit zone to protect your winnings.

Finally, a stop order is utilized to reduce a trader’s losses. You should keep in mind that when you enter a trade, you should have a strategy in place for where you want to exit if the market swings against your predictions.

A stop-order, also known as a stop-loss, is one of the most effective ways to reduce your losses. If you have a long position in a currency pair, you will naturally expect the value of the pair to rise. To avoid generating unmanageable losses, you can place a stop sell order at a certain price, terminating your position instantly if that price is met. On a short position, a stop-buy order will be utilized instead. 

Example of a Stop-Limit Order

A buy-stop limit order would be necessary to restrict losses in a short position. For example, if an investor begins a short position in a certain asset at $60 and wishes to limit losses to 20% to 25%, he or she can put a stop-limit order to purchase at $50 and a limit price of $54. The stop-limit order will be activated if the asset trades between $50 and $54.

This keeps the trader’s losses on the short position within the anticipated 20% to 25% range. However, if the price dramatically increases, the stop-limit order will not be executed, and the short position will remain open and running.

Rules for Stop-Limit Order

When employing stop-limit orders, traders must abide by no specific criteria. This is due to the fact that traders often differ in terms of the amount of risk they are prepared to take. This is commonly referred to as risk tolerance.

Although there are no precise standards to follow, you should be careful when setting price limitations. Because of market volatility, if the price of the orders is too low, they will be executed frequently. This order should be set at a safe level that allows the price to move in a favorable direction while guarding against excessive loss. Limit or take-profit orders, on the other hand, should not be set so far away from the real bid price that they signal an impossible movement in the forex pair’s value.

The difference between a stop-limit order and a stop-loss order

A stop-limit order is identical to a standard stop order but with one additional requirement. A stop-limit order specifies not only a stop price but also a stop limit price. A limit order will be executed if the asset hits the stop price. The deal will only be completed after the trigger price is met and the limit price is achieved.

A stop-limit order can ensure a minimum trading value for sales and a maximum trade value for purchases. The disadvantage is that the order may not be fulfilled even if the stop price is met. If an asset sees a strong price movement, it might go through a trader’s stop limit price. The result is the trader may suffer more risk or losses.

A stop-loss order is an order to purchase an asset as its price rises and reaches a specified stop price, or an order to sell an asset as its price falls and reaches the stop price. The former is known as a buy-stop, whereas the latter is known as a sell-stop.

Typically, investors use sell-stop orders to protect or restrict the losses on a long position. When the stop price is achieved, the stop-loss order becomes a market order and is normally executed immediately.

The great thing about stop orders is that they initiate a trade when an asset’s price becomes unfavorable. The major advantage of a stop-loss order is that it minimizes losses. The order is likely to be performed, but it might be completed at a substantially greater or lower price than what is specified in the order if the price falls or increases too rapidly.

The advantage of using stop-loss orders

Advantage #1: It’s 100% free to use

One significant advantage of a stop-limit order is that it is free to use. It’s a free trading tool that can be used by any trader. A commission is only charged after the price you set for your stop-loss has been met and the asset you invested in needs to be sold. It’s very similar to insurance.

Advantage #2: It saves you time

Another great thing about stop-loss is that you won’t have to sit in front of your computer screen for hours to monitor the asset you are trading. This is especially helpful if you only do trading as a side job. It also comes in handy when you want to take a break or go on a vacation, but you don’t want to miss out on a possible profitable trading opportunity.

Advantage #3: It helps lock in your profits

As previously mentioned, stop-loss is used to secure your profits. Stop-loss orders are sometimes referred to as “trailing stops” in this circumstance since they are set at a percent rate just below the market value rather than the price at which you acquired the asset.

The price of the stop loss varies in tandem with the asset price. However, you have to remember that if the value of an asset increases, you will not be able to keep your earnings until you sell or close your trade. Implementing a trailing stop lets, you continue to make a profit while protecting a portion of your gains from potential losses.

Advantage #4: You have more control of your trades

Stop-limit orders give traders better command over the market. With the use of stop-limit orders, traders can passively invest and capitalize on chances when a market dip ends, and movement for the latest trend continues. Moreover, the orders may be used to open up a position in a trending market when the price surpasses a certain threshold.

When a stop order or limit order is active in the market, investors may also pick when it is active. This is more usually referred to as a time halt. You can choose whether the order is only valid for the current trading session or if it can be carried over to a subsequent trading session.

You may also see if the pending order is still active until you cancel it manually. A trade will expire at the end of the day if it is not performed during the current trading session. In the case of the other options, the order may remain valid until it is executed or canceled manually by the trader.

Advantage #5: It’s an effective risk management strategy

Stop and limit orders are also useful for risk management. Traders may wait until the market reaches a suitable entry price before proceeding with a deal. This ensures that every trade completed with these pending transactions has a favorable risk/reward ratio.

The disadvantages of using stop-loss orders

Disadvantage #1: Your trade might not be executed

Although these orders guarantee a price restriction, the trade may not even be executed. Suppose the stop order activates but the limit order is not completed before the market price moves over the predetermined limit value. In that case, this might be catastrophic for traders in a volatile market setting where the price movement is unpredictable and abrupt.

Assume a company receives bad news, and the limit price is just a dollar below the stop-loss volume. In that instance, the trader must hold the asset for an extended period of time until the item’s price rises again.

Disadvantage #2: Sudden movements in the market may activate your trade

The main drawback is that a quick fluctuation in the price of an asset might trigger the stop price to be implemented. The objective is to select a stop-loss percentage that allows an asset to move on a daily basis while avoiding as many potential losses as possible. Placing a 15% stop-loss order on an asset that is likely to fluctuate by that percentage in a few days is not the greatest idea.

When using stop-loss orders, keep in mind that there are no precise standards to follow. However, it is critical that you analyze the market before placing a stop-loss order. This gives you the information you need to construct an efficient stop-loss order.

Furthermore, keep in mind that if your stop price is hit, your stop order is instantly considered a market order. Consequently, the amount at which you sell or close your deal may fluctuate significantly from the stated stop value. This is a common scenario in a volatile market where asset prices can fluctuate rapidly and unexpectedly.

Conclusion

The stop-limit order is, without a doubt, a very helpful tool or strategy. This is why a lot of traders are instantly sold by the whole concept. But you need to remember that you should never jump in with both feet when it comes to trading, regardless of how fool-proof the strategy seems.

It pays off to familiarize yourself with the strategy before you implement it. It may take a lot of time, effort, and practice to fully understand how it works, but it will be worth it in the long run. After all, minimizing your risks simply means you stand to gain even more.

Just like any trading strategy, it is not perfect. It may advertise that it can minimize your risk, but this does not guarantee that you will always turn a profit. It comes with its own set of risks and conditions as well. So keep in mind that you should only invest the funds that you can afford to lose and thoroughly analyze the market before opening a trade.

Frequently Answered Questions

What is a buy-stop order in Forex?

Buy stop order is an order in which a specified level is hit, your order will automatically be entered. This is different from a buy limit because a buy stop is not technically “entered” until the price is reached. It is sometimes referred to as an invisible order.

How does a buy stop order work?

A buy stop order signals the broker to execute the client’s trade as soon as it reaches a certain value. This type of order is typically entered at a greater stop price than the market price. A stop buys order is used by many traders to reduce a loss or preserve a profit on an asset that they have sold in a short position. A sell stop order is placed with a lower stop price than the actual market price. Investors often use a sell-stop order to minimize a loss or preserve a profit on an asset they own.

How do I set a stop buy in Forex?

The procedure to set up a stop buy varies per broker. However, in general, the broker will require the client to set the limit price and stop price.

What is a trailing stop order?

Trailing stop orders are orders that are entered while trade is still open. This allows investors to establish a stop-loss goal at a fixed percentage of the market rate. As a result, if the price moves in favor of the active trade, the stop point will then be adjusted to maintain the same margin between market value and the stop-loss price.

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