Limit orders
A limit order is an order that's only executed if the price is equal to or better than the one you've specified. For example, suppose the stock in question is trading at $50. If you own the stock, you could place a sell limit order to sell the stock only if the price is $55 or higher. Or you could place a buy limit order to purchase the stock, indicating that $45 is the maximum amount you're willing to pay.
What is a stop-limit order?
A stop-limit order is an order that combines features of a stop order and a limit order. Like a stop order, it's only triggered if the price of a security hits a price target you've set. However, as with a limit order, it won't be executed if the price moves away from the price you've specified.
Let's say that you own a stock that trades for $100. You want to sell it if the price tumbles to $95, but you're unwilling to accept less than $90.
You could place a stop-limit order designating the stop sell price as $95. Once the price hits $95, the order will become a market order. But if the price drops below $90, the order won't be fulfilled because of the $90 limit order you placed.
On the flip side, if a stock trades at $100, you may want to buy it if the price hits $105 to avoid missing out on an opportunity. But you may not think it's worth more than $120, so you could set $120 as the limit price to avoid buying an overvalued stock.
Why traders use stop-limit orders
Traders primarily use stop-limit orders to protect against stock market volatility. Stock prices can swing wildly in the short term.
When you want to sell a stock, a stop-limit order can reduce your risk of big losses when the market panics. If you're buying stocks, a stop-limit order can help you get in on a stock whose price is rising rapidly, while also allowing you to avoid overpaying. Using a stop-limit order can be helpful if you're prone to trading based on emotions when the stock market is on a wild tear by automating the decision-making.
You probably don't need stop-limit orders if you're a buy-and-hold investor, though. Stock market ups and downs are completely normal. Long-term investors focus on businesses with solid fundamentals and ignore short-term market fluctuations.
