People are wary of the stock market because of the wide price swings. A stock that ended the last trading day at $55 trades at $40 on the opening bell the following day. Investors take this risk whenever they put their money in the stock market, knowing full well that the market can and often does experience extreme volatility. When placing an order, gaps are inevitable.

Limit And Stop-Loss Orders

For the argument, let's pretend that you have a significant investment in the firm XYZ. You set a stop-loss order at $50, and it's currently trading at $55. Once the price drops below $50, your order will be placed, but it doesn't ensure you'll be exited at or near that price. However, if you placed a limit order to sell at $50, but the stock opened the next day at $40, your limit order would not be completed, and you would still own the shares.

When Should You Use a Stop-Limit vs. Stop-Loss Order?

A stop-loss order automatically converts when a specific price is reached into a market orders. A specific price is reached, a stop-limit automatically converts into a limit order. Stop orders and stop-limit orders, in contrast to conventional market orders, do not take effect until the specified price is reached. 1

Both stop and limit orders protect open positions from further losses or profit from swing trading opportunities.

Stop-limit orders include the limit price the order is filled at, whereas stop-loss orders ensure execution only if the position reaches a specified price. In either the long or short position, an investor can enter a stop-loss or stop-limit order, the specifics of which will vary depending on the investor's position and the current market price.

Potential Benefits and Drawbacks

Both forms of orders have their benefits and drawbacks. Both can be used as a kind of insurance against a decline in the value of an investment. However, there are essential distinctions in executing such orders and costs and execution standards.

Advantages

Stop-Loss Orders

• Safeguards underperforming securities from further losses
• Assures that a transaction will take place
• Safeguards against short-term fluctuations
• Assists in mitigating financial damage if security moves against an investor's position by

Stop-Limit Orders

• Cushions the blow of wildly fluctuating prices
• Assures a minimal trade execution price
• Traders are given some wiggle room if the limit price isn't met, which is a definite plus.
• To help mitigate loss if a security price swings against an investor's position,

Disadvantages

Stop-Loss Order

• Provides almost no room for maneuver because the order will execute automatically if the stop loss price is reached
• When triggered, executes at the current market price, which, depending on open market trades, may be lower than the stop order loss price.
• Participants run the danger of having their stop levels breached by other investors.

Stop-Limit Order

• There is no assurance that the trade will be performed even if the trigger price is reached due to the difference between trigger price and limit price
• Puts traders in danger of having their stop-loss orders triggered by other traders
• Could include a hefty commission cost if the broker doesn't provide the service for free.

What Are Price Gaps?

The term "price gap" describes the abrupt increase or decrease in stock prices between the closing of one trading day and the opening of the next, with no trading occurring in between. Investors frequently look for equities with significant disparities between their opening and closing prices to identify undervalued buy and sell opportunities.

Consider a scenario where you have a limit order to sell a stock at $55, and the stock is trading at $47 at the market's closing. The stock opens at $65 because of encouraging economic statistics or news. The deal will be completed at $65 instead of the more favorable $62, increasing the seller's profit.

Do Regular Investors Use Stop-Loss And Stop-Limit Orders?

Investors can employ stop-loss or stop-limit orders to hedge against losses and lock in winnings. Stop-loss orders are often offered at no cost to investors by their present broker, but stop-limit orders may include a brokerage charge.

The Bottom Line

Both long and short investors can benefit from stop-loss and stop-limit orders in different ways. Both stop-limit and stop-loss orders are guaranteed to be executed, but only stop-limit orders are guaranteed to be filled at the requested price.