Getting To Know Your Stop Limit Orders
By Ultimate Trading
You Must Learn When To Effectively Set Your Stop Limit Orders
There are two types of stop limit orders that you will use
constantly as a trader, protective stop limit orders and trailing
stop limit orders. Generally, positions start out with protective
stop limit orders
to guard your investment, and move to trailing stop limit orders
when the trade becomes profitable. But the best way to familiarize
yourself with stop limit orders, and how to set them is to consider
them being used in a trade.
Let's say you take a long position in a stock in anticipation of its
earnings announcement. It had traded at around $13 for many weeks,
but last week it ran up to $16, as the first sign of its earnings
run. It then slowly dropped to $14.40 over the course of two days
and stabilized there for a day and a half.
Today it's started to slowly move up again, and you think it'll keep
going. You decide to buy, and put in a limit buy order at $14.8,
which executes at $14.76. Since it isn't the strongest company and
the market has been flat, you decide to a reasonably tight
protective stop limit orders. You don't want to set it too tightly,
though, since the stock isn't very volatile and the time frame for
your trade is about five days. Its important to set protective stop
limit orders below support levels, so you look to see where the
stock has support.
There are two support levels: $13, where it traded for weeks, and
$14.40, where it stabilized recently. Its resistance level is $16.
If the stock moves down from where you bought it, it will almost
certainly bounce at $14.40. If the stock then drops below $14.40,
you would assume it isn't ready to move up yet, and you'd be better
off stopping out there and buying again later. For this reason, you
also determine there's no reason to let the stock move all the way
down to $13.
Therefore, you set protective stop limit orders at $13.75. You don't
want to set it right at $14.40, since the stock will bounce near
$14.40 and then either start back up or continue down. For the same
reason, you don't set the stop above $14.40. But $13.75 seems a good
place to stop, since no support level is absolute, and the stock
could bounce off $14.30, or $14.50, as easily as it could bounce off
$14.40. If the stock gets as low as $13.75, though, that would
suggest that the stock will actually break through support. The rule
is that a clear break of support is dictated by where a stock
closes, not by intraday swings.
Lets say youve made a good trade, and the same stock rises to
$15.10, stays there for a period of time, dips sharply to $14.43,
and then picks up volume and rises rapidly. It breaks through its
new resistance at $15 and starts the climb to $16. The market is
Now is the time to start to think about using trailing stop limit
orders to protect your profit. You're starting to accumulate a nice
one. At $15.50, you've made 5%, and if the stock hits $16.24, your
profit will be 10%. You decide that the stock should stay above its
old resistance of around $15 unless something unexpected occurs. Now
that the stock has broken $15, that price will serve as a new
support level. Remember, old resistance becomes new support. You
move your stop limit orders up to $14.85.
The stock could pull back a bit at $16, since that level served as
the ceiling before. When the stock nears $16, you can choose to
either take profits by selling out directly or by setting a very
tight trailing stop, or by increasing the looser stop limit orders
trigger to 15.30 in anticipation of further upward movement. At $16
the stock will already have moved up almost 25% from its long-time
price of $13, and it may not rise through $16 so easily. You decide
to set tight stop limit orders once it hits $16 instead of selling
out, just to give it a chance. So once it hits $15.70, you move your
stop up to $15.20; when it hits $16, you move the stop up to $15.75.
The market's rally intensifies after great earnings reports from
three leading companies, and your stock runs up to $16.73 before it
begins to fade. You quickly sell out at $16.68 for a nice 13%
profit. If it had pulled back after hitting $16, you would have
stopped out at $15.75 with a profit of nearly 7%. You could then
have re-bought the stock if it dropped even lower and you were still
convinced that it would eventually move up again.
This example demonstrates effective ways to use both protective and
limit orders. Though each trade is unique, stops will always
perform the critical tasks of protecting your investment, and
locking in your profit, if you use them properly. Once youve
mastered the art of setting stop limit orders, you will find your
profits will greatly exceed your losses, and you will be well on
your way to trading success.
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Stop Limit Orders