Stop and limit orders are direct opposites. A limit order is jargon for “better price”, while a stop order means “worse price”. Many find it especially confusing that a stop entry order uses the same terminology as a stop loss. Technically, they are the same thing. A stop entry and stop loss are both prices worse than what you would get if you accepted the current market price.
Stop entry versus limit entry
Stop entries are used with momentum or breakout strategies. The theory is that if the price moves up, then it will be more likely to continue moving up. The trader loses out on the difference between the price at the time he decided to trade and the actual entry price. What he hopes to gain is the extra information that the price has moved, which might imply a higher probability trade.
A price that is worse the current market price for buying in the future is up. So, buy stops go above the current market price. Sell trades receive a worse price in the future if they wait and the price goes down.
Limit entries take the opposite approach. Market often tend to wander. They very rarely shoot off in a single direction without wiggling a little bit up and down. The idea behind a buy limit order is that you think that the price will increase in the future, but that you might be able to pick up the fx pair at a better price than what you’re seeing now. A buy limit goes below the current market price. A price improvement for a sell entry requires a price increase, so sell limit entries always go above the current market price.
Stop loss exit and limit exit
Most people find this part a lot simpler. Here, a stop loss means you lose money. The buy trade that you opened is going down. If it hits your stop loss, then the loss is realized. Stop losses go below the entry price for a buy trade and above the entry price for a sell trade.
Limits are the opposite. An open long trade is a bet that the price will increase. If it hits your limit exit, it means that you’re satisfied with the amount of profit on the table. Long trades place the limit above the entry price. Short trades place the limit exit below the entry price.
[…] the stock market is also corrupt, at least setting a limit order actually shows through on the ticker. Most forex traders, amazingly, are not aware that this is how […]