Stop-Limit Order: What It Is and How to Use It

Trading

Glenn BONΞZ Bona
11.4.2021
In this guide, we dive into the stop-limit order and how you can successfully use it in your crypto trading strategy.

When investing in crypto, it is essential to have a good risk management strategy. A stop-limit order can help you with this when you buy cryptocurrencies. It triggers a sale at a preset value when the price of your asset goes up or down. This order type helps significantly with the volatility of the crypto market.

Before entering the market, it is always a good idea to do your own research (DYOR) and investigate the fundamentals of a crypto project. You are hitting it home when you combine this with technical analysis and apply trading tools correctly. In addition, this research gives you a better understanding of finding the best moments to enter or exit a position.

A stop-loss limit is a perfect trading tool to help you exit the market at a moment that you predetermine. It is an easy-to-understand and easy-to-use tool. A stop-loss order will sell your crypto asset when the price drops, at a preset price, limiting your losses. A stop-limit order, on the other hand, will sell your cryptocurrency when the price increases. It will guarantee that you can make a profit or protect yourself from buying at an inflated rate.

The advantage of this investment strategy and to use stop-limit orders when trading, is that it allows you to set trade limits to your preference, and you don't need to keep an eye on the charts at all times. The stop-limit orders will execute automatically once your specified price levels are reached. Crypto exchanges are open 24/7 and don't stick to typical stock exchange market hours. Their trading day and trading hours don't take a break. One more reason to integrate a stop-loss limit when trading crypto.

What are three common order types?


The three common order types are limit orders, stop-loss orders, and stop-limit orders. Each of these three types of orders fulfills a different purpose in a trading strategy.

What is a limit order?

A limit order is when you set a maximum buy price or a minimum sell price. The order will be filled by your exchange when the market reaches the specified limit price or better.

There are two different limit orders.

What is a stop-loss order?

Traders can place a stop-loss order below or above the current market price. Once an asset's price reaches a specified price, it triggers a market order. Consequently, the final price can vary because your asset is sold at the next available price. This execution price is not necessarily the predetermined price that has been set as the stop-loss. When a trader wants to take a predetermined profit, it can be called a take-profit order.

What is a stop-limit order?

A stop-limit order combines a stop-order and a limit order. It helps to control the purchase price once an acceptable minimum or maximum price for a cryptocurrency is determined. This tool has a stop price that acts as a trigger, and it will place a limit order. Theoretically, a trader can set the stop and the limit prices at the same value, but it isn't necessary.

It is safer to set the stop price slightly higher than the limit price for a sell order. For a buy order, it's best to set the stop price somewhat lower than the limit price. When triggered, it increases the likelihood of filling your limit order.

How does a stop-limit order work?

Stop-limit orders don't work in mysterious ways but follow an easy-to-follow set of steps to determine the maximum or minimum prices for each order. First, a buy stop-limit order is placed above the market price. Then, a sell order is placed below the market price at the time of the respective orders.

Stop-limit orders are completed at specified prices, or better, once a predetermined stop price is reached. Once the stop price is reached, the stop order turns into a limit order and buys or sells at the limit price, or better.

It is possible to set a time frame for the duration of the order, with the option of good-til-cancelled (GTC) being available as well.

When setting up a stop-limit order, you need to consider setting three price points in the specified box on your exchange.

  1. Stop — This is where a specified target price starts a trade. The sell stop-limit order turns into a limit order when the specified bid drops to or dips below the stop. A buy stop-limit order also turns into a limit order as soon as the lowest ask price has raised to or exceeds the stop.
  2. Limit — This is the specific price at which a trade is executed, just like a standard buy or sell order. Once reaching the highest bid or lowest ask price, the stop-limit order is triggered. It will turn into a regular limit order, dictated by the price entered in the limit field.
  3. Amount — Each exchange, with a stop-limit option, will have a box where the stop-limit order can be placed. In this box, the percentage can be set for how much of the asset should be traded. In general, this will go on a sliding scale, with 25% increases from 25% to 100%. Traders have the option to change the percentage number to their liking.


Buy stop-limit order example

The easiest way to explain a buy stop-limit order is by giving an example. A stop-limit order involves two prices.

Look on an exchange for the buy/sell box. Click on the stop-limit button, and you should see four rows in which to add information. Stop, limit, amount, and total, although the wording can change between exchanges. Besides these four rows, there should also be a slider that allows you to set the percentage of funds to spend on this trade.

An ordinary trading pair is BTC/USDT. Once at the buy/sell box, the exchange will tell you how much USDT is available for the trade. Enough funds should be available to execute the required trade. Make sure, when trading on a crypto exchange, that the correct trading pair is available.

If BTC is trading at $60,000 and the highest chosen entry point is $62,000, the stop can be set at $61.800. This will trigger a limit order at $62,000, but not above $62,000. If a market moves up quickly and overshoots the limit order quickly, the order may not be filled completely.

The stop price is now $61,800, and the limit price is set at $62,000.

Once the buy button is clicked, all relevant information of the buy should become available, telling what is about to happen. The only thing left to do is to approve or confirm the buy. If the trade has not gone through, it is possible to manage open orders. They can be canceled or replaced by a different order.

Sell stop-limit order example

Just as with the buy order, an example will clarify how a sell stop-limit works. This order is vital for covering a potential market dip. Once more, we see two prices in the buy/sell box of an exchange. The stop price, which triggers a limit order to sell and a limit price, is the lowest price a trader wants to sell.

Like the previous sample, click on the stop-limit button in an exchange's buy/sell box, but now at the sell-side. The four rows to fill out will show with the slider. Again, confirm that the chosen trading pair is available.

If a trader buys BTC at the current price of $60,000, and afterwards the BTC price hits $62,000, there is a possibility that the price drops again. Losses can be prevented by setting a stop-limit order by selling at the entry point. Set up a stop point at $60,300 with a limit at $60,000. Once the price of BTC reaches $60,300, a limit order is placed to sell at $60,000; the exact price BTC was purchased.

The stop price is now $60,300, and the limit price is set at $60,000.

What are the benefits of using a stop-limit order?

The most important benefit of a stop-limit order is controlling when an order is to be filled. Then, it is possible to set up an entry or exit strategy on your terms. Because the crypto market is open 24 hours, 7 days per week, it isn't possible to constantly watch the market. Setting up a stop-limit order gives peace of mind, knowing that your risks are covered.

One more benefit is that assets are not sold at whatever the market price is (the stop) but at limit order prices. The advantage is that it is possible to hold on to an asset rather than sell at any cost, created by the difference between stop and limit parameters.

What are the challenges to using a stop-limit order?

The biggest challenge of using a stop-limit order is when the order doesn't fill. There is no guarantee that an order will execute. It is also possible for the price to overshoot the spread in the order.

Similar to limit orders, they only fill when they reach a predetermined price or better. However, the price that has been set may not be reached. With a stop-limit, it is possible to create a gap between the stop and limit prices. However, the gap may not be big enough. With a breakout or fast rise in price, volatile cryptocurrencies can overshoot the spread placed in the order. The same can happen at a sell stop-limit order, when the price of an asset dumps rapidly, overshooting the spread.

Another issue to be aware of is liquidity. There need to be enough takers for filling an order. No fills or partial fills may be a potential problem. A "fill or kill" or "all or none" option is available to avoid this situation. This means that the order can only execute when it is fully filled. The disadvantage of adding conditions to an order is that it becomes more difficult for an order to execute at all.

Trading Strategies When Placing Stop Limit Orders

We talked a lot about stop-limit orders, and now it is time to start using them. So what is the

best way to go about this? A couple of easy-to-understand trading strategies can help make stop-limit orders more effective and avoid some problems they can create.

Volatility

When putting a stop-limit order in place, the volatility of the asset to be traded needs to be understood. If the market or the chosen cryptocurrency is volatile, a wider spread between the stop and the limit prices may be required.

Technical Analysis (TA)

Studying and analyzing crypto trading charts is advisable. Many trading tools are available that can help with this. Various moving averages, trend lines, or for advanced traders, a Fibonacci retracement may all be helpful. Support and resistance levels can be beneficial for setting stop prices. Prior support or resistance levels can also indicate an increase in liquidity once similar levels are reached. A horizontal line is a tool that can recognize these points.

Trading volume and liquidity

Both liquidity and trading volume of the targeted cryptocurrencies should be studied. Knowing the trading volume helps determine if a stop limit is needed at all and at what point it should be placed.

It is quite possible that coins with high liquidity may not need these orders at all. On the other hand, if a coin is particularly illiquid, it may be a good idea to lower the size of a position, demonstrating due diligence with risk management.

Conclusion

Fast-moving markets like the crypto markets require a good trading strategy to be successful. Implementing stop-limit orders helps with risk management and can make a difference when making profits or preventing increased losses.

Stop-limit orders work across the board in markets for crypto, stock, and forex. As a result, traders and investors in all three of these commodities can profit from the advantages that stop-limit orders bring to the table. Combined with technical analysis and being aware of the volatility of the crypto market, in particular, they are an essential tool for experienced traders and newcomers to manage risk.  

We hope you enjoy this addition to our educational content on your journey to become or remain a successful trader. With this in-depth look at stop-limit orders, we like to bring closer this helpful tool to investors and traders. The limit order and other tools can be used at a CEX or DEX, making trading easier and more manageable by giving you a better grip on the associated risks.

An additional tip is joining our Telegram community and our newsletter, where we answer further questions and update investors on company news related to Matrixswap.

We look forward to hearing from you.

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