Stop Limit Order: Everything to Know
By Beluga Research August 28, 2023
- A cryptocurrency stop-limit order is a trading instruction that combines a stop order and a limit order
- They allow traders to specify a stop price and a limit price for buying or selling assets
- This type of order helps a trader protect profits, limit losses and manage risk in volatile markets
- Negative consequences of a stop-limit order can include missed opportunities and execution at unfavorable prices
A cryptocurrency stop-limit order is a trading instruction that combines a stop order and a limit order. The stop order is an order to buy or sell a particular type of cryptocurrency when it reaches a specific price. The limit order requires the trade to be at a certain price that the user set. A stop-limit order involves buying or selling the cryptocurrency when it reaches the specific price, with the trade occurring at the price the user specified. A stop-limit order helps a user avoid buying or selling at a price that is above or below a desired amount.
A Brief History
Stop-limit orders originated in traditional stock markets. They have been used for decades. They provide traders with more control and help mitigate risks from price fluctuations. Cryptocurrency exchanges have adopted the concept of stop-limit orders to give users a way to profit in the volatile crypto market.
Stop-limit Order: Everything to Know
When placing a stop-limit order, traders specify two key parameters, the stop price and the limit price. The stop price triggers the order. The limit price sets the minimum execution price. Here are several different scenarios for using stop-limit orders:
- Buying with a Stop-limit Order. A trader can set a stop-limit order to automatically buy an asset when it reaches a certain price. Say bitcoin is trading at $40,000 and a trader expects it to rise above $42,000. They can set a stop price of $42,000 and a limit price slightly above, like $42,100. When the price hits $42,000, the stop-limit order triggers. A limit order to buy bitcoin at $42,100 is placed. This allows the trader to enter a position at a specific price without constant monitoring.
- Selling with a Stop-limit Order. A trader can use a stop-limit order to automatically sell assets when the price drops. This strategy protects profits and limits losses. Say a trader holds ether and wants to secure gains if the price drops to $3,000. They can set a stop price of $3,000 and a limit price slightly below that, at $2,950. When the price hits $3,000, the stop-limit order triggers. The limit order to sell ether at $2,950 is placed. A stop-limit order can help a trader minimize financial harm when the market turns bearish.
- Managing Risk with Stop-limit Orders. A trader can guard against losses by setting the stop price below their entry point. This strategy is called placing a trailing stop-limit order. Say a trader buys XRP at $1.50 and wants to limit potential loss to 10%. They can set a stop price at $1.35 and a limit price slightly below, like $1.34. When the price drops to $1.35, the stop-limit order triggers. The limit order to sell XRP at $1.34 is placed.
- A stop-limit order helps a trader understand the market better. A trader can use this tool to learn whether their investment strategies are working, i.e. are generating profits. If not, they may need to change their limit price.
- A stop-limit order helps a trader understand how much risk they want to take. The crypto ecosystem is extremely volatile. When a trader looks at how a particular stop-limit order functioned for them, they can determine whether they want to assume more risk.
- Experience with stop-limit orders in the stock market helps with understanding stop-limit orders in the crypto ecosystem. A trader who has utilized stop-limit orders before will have an advantage over one who is unfamiliar with the concept. Education regarding stop orders, limit orders and stop-limit orders benefits new users and the crypto ecosystem as a whole.
- Provides traders with more control over the execution price of their trades. By setting a stop price and a limit price, a trader can ensure that their orders are executed within a specific price range. This is particularly useful in volatile markets.
- Helps traders protect their investments and minimize potential losses. Say a trader holds a cryptocurrency purchased at $100 but wants to limit potential losses if the price drops. They can set a stop price at $90 and a limit price at $85. When the price reaches $90, the stop-limit order is triggered. It is converted into a limit order to sell at $85 or better. This allows the trader to exit the trade before incurring further losses.
- May not always execute if the market moves rapidly and the limit price is not reached. In fast-moving markets, a price that is in motion can skip over the limit price. This results in the order remaining open and unexecuted. The phenomenon is known as "slippage." Traders should be aware that slippage may occur. They should consider setting their limit prices accordingly to increase the likelihood of execution of trades.
- Precision. Stop-limit orders provide precise entry and exit points for trades, enabling traders to execute their strategies more effectively.
- Risk management. Traders can manage risk exposure by setting predetermined stop prices. When the market reaches the stop price, the order is triggered, minimizing potential losses.
- Control over execution. Traders have control over the execution of their trades, setting the desired buying or selling price.
- Protection against market fluctuations. Stop-limit orders act as safeguards against sudden price swings in volatile cryptocurrency markets. Traders can protect themselves from significant losses by setting a stop price.
- Automation. Stop-limit orders can be automated, allowing traders to execute trades even when they are not actively monitoring the market.
- Time-saving. Traders can save time by using stop-limit orders. The orders can be executed automatically when the specified conditions are met.
- Missed opportunities. In fast-paced, volatile markets, if the market moves rapidly and bypasses the specified stop price, a stop-limit order may not be executed. This causes the trader to miss investment opportunities.
- Execution at unfavorable prices. Certain market conditions may lead to the execution of a stop-limit order at a less favorable price than anticipated. The lower price is usually due to insufficient liquidity or a sudden price gap.
- Over-reliance on technical analysis. Stop-limit orders rely heavily on accurate price predictions and technical analysis. Flawed analysis or unforeseen events can lead to undesired outcomes.
- Complexity for beginners . Novice traders may find stop-limit orders complex to understand and utilize. These orders require a deep understanding of trading concepts and strategies.
- Additional fees: Some cryptocurrency exchanges charge extra fees for placing stop-limit orders. Traders should consider these fees when evaluating the cost-effectiveness of using stop-limit orders.
- Limited control in highly volatile markets. In extremely volatile markets, rapid price fluctuations can make the execution of stop-limit orders challenging. This can result in unexpected and undesired outcomes, such as retention of unwanted cryptocurrencies and loss of profit.