Stop Loss VS Stop Limit is a very confusing topic, they sound similar but are they the same?
In the previous article we covered the difference between Stop Loss VS Limit Orders.
In this article we’ll clarify the Stop Loss VS Stop Limit and the difference so you can use them without hesitation.
What Is a Stop Loss Order?
You would place a stop loss order to automatically close a trade at a specified price.
The purpose of a stop loss order is to limit potential losses and protect the trader’s account from significant drawdowns.
It is for this reason that is is one of the most popular order types in Forex trading.
Let’s say you buy a currency pair at $1.1000 and set a stop loss order at $1.0900. The price of the currency pair drops to $1.0900. The stop loss order will trigger, automatically closing the trade and limiting your potential loss.
Advantages of Using a Stop Loss Order
- Limits potential losses: By setting a stop loss order, you can limit your potential losses and protect your account from significant drawdowns.
- Provides peace of mind: Knowing that you have a stop loss order in place can help you feel more confident and less emotional when trading.
Disadvantages of Using a Stop Loss Order
- May be subject to slippage: In some cases, the trade may be executed at a different price than the stop price due to market volatility or liquidity issues.
- May limit your profits: If the trade moves in your favor but then retraces and hits your stop loss, you may miss out on potential profits.
What Is a Stop Limit Order?
A stop limit order is similar to a stop loss order, but with one key difference.
With a stop limit order, you set both a stop price and a limit price.
The stop price is the price at which the stop limit order will trigger, and the limit price is the minimum price at which you are willing to sell the currency pair.
For example, let’s say you buy a currency pair at $1.1000 and set a stop limit order with a stop price of $1.0900 and a limit price of $1.0850.
If the price of the currency pair drops to $1.0900, the stop limit order will trigger, and a limit order will be placed to sell the currency pair at a minimum price of $1.0850.
Advantages of Using a Stop Limit Order
- Provides price flexibility: By setting a limit price, you can ensure that your trade enters at a minimum price.
- Reduces the risk of slippage: If you set a limit price, the trade is less likely to experience slippage.
Disadvantages of Using a Stop Limit Order
- May not execute: If price doesn’t reach the limit price the trade will not execute, which could result in missed opportunities or potential losses.
- Requires more active management: You may need to monitor the market closely to ensure that the trade executes at the desired price.
Stop Loss vs. Stop Limit Order: Key Differences
There are some key differences between stop loss and stop limit orders that you should be aware of before choosing which one to use:
Image from Cashforex.
Price Flexibility
When it comes to price flexibility, stop loss and stop limit orders operate differently.
As mentioned earlier, stop loss orders do not provide any price flexibility. The trade will execute at the market price once the stop price hist.
Stop limit orders instead provide price flexibility because the trader sets a limit price ensuring the trade triggers at a minimum price.
If a trader buys a currency pair at a certain price and sets a stop loss order at a lower price, the trade will close automatically at the current market price once the stop price hits.
This could lead to a loss that is equal to or greater than the stop loss price.
But, if the trader sets a stop limit order with a stop price and a limit price, the trade will only be executed if the market price reaches the stop price, and the trader will sell the currency pair at a minimum price.
This protects the trader from selling the currency pair at a lower price.
Slippage
Another significant difference between stop loss and stop limit orders is the likelihood of slippage.
Slippage occurs when the trade is executed at a different price than the stop price due to market volatility or liquidity issues.
Stop loss orders may experience slippage as the market price may gap below the stop price during periods of high volatility, resulting in a larger loss than anticipated.
Moreover, stop loss orders can experience slippage due to low liquidity in the market, resulting in the order being filled at a price lower than the stop price.
Stop limit orders, however, are less likely to experience slippage as the trader sets a limit price.
This ensures that the trade will not be executed below the limit price, providing more control over the execution price.
Execution Guarantee
When it comes to execution guarantee, stop loss orders are safer than stop limit orders.
In this case, once the price hits the stop loss level the order triggers, regardless of market conditions.
On the other hand, a stop limit order does not guarantee execution as price might not reach the limit level.
This means that if the market moves too quickly, the trade may not execute, leaving the trader with a potentially larger loss.
Therefore, if your priority is to ensure that you enter a position, even in the event of volatile market conditions, a stop loss order may be the better option.
However, if you want more control over the execution price and are willing to take on the risk of not entering the trade, a stop limit order may be a suitable alternative.
Which Order Type Should You Use?
The order type that you use depends on your trading strategy and risk management goals.
Suppose you want to limit potential losses and protect your account from significant drawdowns.
In that case, a stop loss order may be the best option.
This is especially true for beginner traders who are still learning to manage risk and may not have a lot of experience trading in volatile markets.
However, if you want to provide price flexibility and ensure that you enter a trade at a minimum price, a stop limit order may be the best option.
This is useful when trading in a market with low liquidity or high volatility.
It’s important to note that both stop loss and stop limit orders have their advantages and disadvantages.
Traders should carefully consider their trading goals and risk management strategies before choosing an order type.
Suppose you are unsure which order type to use. In that case, you can always consult with a trading professional or conduct additional research to determine the best order type for your needs.
Entry VS Exit
A very short way of deciding which order to use could be the following
- Traders commonly use Stop Limit to entry a trade following a price “expectation”
- Traders usually use Stop Loss to exit a trade managing the risk
Effective Risk Management Techniques
Regardless of the order type that you choose, it’s crucial to implement effective risk management techniques to ensure the success of your trades. Here are some risk management techniques that traders can use:
- Determine your risk tolerance: Before placing any trades, determine your risk tolerance and the maximum amount of money that you are willing to lose on a single trade.
- Use appropriate position sizing: Use appropriate position sizing to ensure that your trades are not too large relative to your account size.
- Set stop loss and take profit orders: Use stop loss and take profit orders to limit potential losses and secure profits.
- Monitor market conditions: Monitor market conditions to stay informed about any news or events that could impact your trades.
- Diversify your portfolio: Diversify your portfolio by trading different currency pairs and using different trading strategies to spread out your risk.
Conclusion
Stop loss and stop limit orders are two commonly used order types in forex trading.
They help traders manage risk and protect their accounts from significant losses.
Understanding the differences between these two order types and knowing how to use them effectively can help you optimize your trading performance and maximize your profits in the forex market.
Remember to always implement effective risk management techniques and monitor market conditions to ensure the success of your trades.
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