Cryptionary: Stop Limit Order - Definition

concept

A Stop Limit Order is a type of order that combines the features of a stop order and a limit order. It becomes active once a certain price, known as the stop price, is reached. Once active, it behaves as a limit order and will only be executed at the limit price or better. This two-stage mechanism provides traders greater precision in controlling their entry and exit points in volatile markets. The stop price triggers the order's activation, while the limit price sets the minimum or maximum execution price.

stop limit buy

Carol wants to buy BCH, but only if a bull run is confirmed. She sets up a stop limit buy order with the stop set at $1000 USD/BCH, currently the price is at $800 USD/BCH. Carol's order will not execute until the price reaches $1000 USD, at which point it becomes a limit order. The order will only be filled at $1000 USD/BCH or a better price. This ensures she doesn't miss the upward momentum while still protecting herself from paying too much.

stop limit sell

Carol wants to set up a stop loss order as insurance against the price drastically dropping while she is on vacation. She sets up a stop limit sell order for her 5 BCH at $699 because she believes that if the price drops below $700 it will go down even further. If the price hits $699, Carol's stop loss will execute and a limit order selling 5 BCH will be placed. The order will only be filled at $699 USD/BCH or a better price, providing some protection against flash crashes.

components

A Stop Limit Order consists of two critical price points:

Stop Price: The price at which the order is triggered and converted to a limit order
Limit Price: The price at which the order may be filled after activation

These can be set to the same value or different values depending on the trader's strategy and risk tolerance. When the stop and limit prices are set to different values, it creates a price range within which the trader is willing to execute the trade.

Example 2.1

"Bob places a stop limit sell order for ETH with a stop price of $2,500 and a limit price of $2,450. When ETH's price falls to $2,500, the order activates and becomes a limit order that will sell at $2,450 or higher. This gives Bob protection against significant slippage, though it also creates the risk that the order might not execute if the price falls rapidly below $2,450 without any trades at or above that price."

benefits

Stop Limit Orders provide traders with more control over the buy and sell prices. They can be used to:

Protect profits by automatically selling when prices begin to decline
Limit losses by setting predetermined exit points
Initiate new positions when the market breaks out of a range
Reduce emotional trading decisions by automating entries and exits
Execute trades when the market makes moves while the trader is away
Manage risk across multiple positions simultaneously

Example 3.1

"Stop Limit Orders are a powerful tool for traders to implement disciplined trading strategies. A trader might use a trailing stop limit order to protect profits during a bull run, automatically adjusting the stop price upward as the market price increases, while maintaining a fixed difference between stop and limit prices to control execution risk."

risks

While Stop Limit Orders can be beneficial, they also come with specific risks:

Execution Risk: The order may not be executed if the market price surpasses the limit price before the order can be filled
Gap Risk: During significant market events or low liquidity periods, prices may gap through both the stop and limit prices
Slippage Risk: In fast-moving markets, the price might trigger the stop but move rapidly away from the limit price
Technical Failures: Exchange outages or connectivity issues can interfere with order execution
Market Manipulation: In thinly traded markets, price manipulation could trigger orders at unfavorable levels

Example 4.1

"During a flash crash on a major exchange, Alice's stop limit sell order with a stop price of $30,000 and limit price of $29,800 for Bitcoin was triggered when prices fell rapidly. However, the price fell so quickly that it dropped below her limit price before any trades could be executed at her limit price. Her position remained unsold, exposing her to further price declines before the market eventually recovered."

advanced

Advanced traders combine Stop Limit Orders with other order types and strategies to create sophisticated trading approaches:

Bracketed Orders: Combining stop limit and take profit orders around a position
Trailing Stop Limits: Automatically adjusting stop prices as the market moves favorably
OCO (One-Cancels-Other): Pairing stop limit orders with take profit orders
Iceberg Orders: Breaking large stop limit orders into smaller chunks to avoid market impact
Time-In-Force Modifications: Adding expiration parameters to stop limit orders

Example 5.1

"Professional traders often use bracketed orders to manage risk. For instance, after buying Bitcoin at $35,000, a trader might simultaneously place a stop limit sell order with a stop at $33,000 and limit at $32,800 to protect against downside risk, while also placing a limit sell order at $40,000 to take profits. Some exchanges offer this as a single order type that automatically manages both sides of the trade."