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Buy Stop Orders Or Buy Limit Orders? What They Are And When To Use Them
John Williamson
2020-05-09 246

I remember placing my first trade, back when it was still commonly done over the phone – yes there a time when not everyone traded online!


Back then I was new to trading and the internet. And I was more comfortable placing my orders with a real human being than using a trading platform. 


I had a strategy but the whole trading process felt clumsy. I wasn’t quite sure about all these order types things for one.


Stop orders, limit orders, market orders good til cancelled, OCOs – what was that all about?


Looking back I was pretty damn clueless thinking about it.


It's understandable though whenever we learn something new – and it's even more understandable when we are risking our hard-earned money.


In this post, I am going to discuss the two main types of entry orders that you can place here at Mitrade.


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So you don’t have to be quite as nervous as I was when I began.


Entry orders are the building blocks of a trading strategy. They’re our work tools, just the same as a chisel, hammer and nails are the tools to a craftsman.


And like any work tool, we have to know how to use them so we don’t hurt ourselves.


I am going to break down order types explain why you use them, and when you should use them. 


Oh, how I wish I’d had this article to guide me back then!


Before I do talk about stop orders and limit orders though it's essential I first explain to you another basic order, the market order.

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What Is A Market Order?

If you were to buy an asset right now, let's say Gold, you would be placing a market buy order. You hit the buy button, and suddenly the order has gone through onto the trading platform.


You could actually see your position come up on the screen right there in front of you.


This is the simplest order type. If you wanted to then sell the Gold five minutes later, you could hit the sell button, and hey presto you have placed a market sell order and your Gold has been sold.


This is the most basic order and the one I’m sure most people would be familiar with most.


Even non-traders have made use of this from time to time as they make the odd purchase of stock for their long-term portfolio.


This is also the type of order used by scalpers. For them, this type of order is convenient, it's quick. But scalpers are at their trading terminals watching the market closely so they don’t need to use more advanced orders allowing you to walk away from the screen and go about your normal day.


Buy Stops Vs Buy Limits

There are four advanced order types common to all trading platforms.


Buy stop, sell stop

Buy limit, sell limit


Were about to embark on an in-depth discussion of stops and limits. While I am going to talk specifically about buy stops and buy limits the same applies to sell stops and sell limits – but in reverse


Depending on what type of trader you are will determine your order type preference. 


●  Buy stops


A buy stop is an order to buy, that is placed above the current market price.


Why on earth would anyone want to buy something above the current market price you might be asking?

It’s a fair question, and one I also couldn’t figure out when I began my trading career.


But there’s a reason, let me explain to you.


You see things that work in real life don’t work when it comes to trading markets and vice versa.

In the real world, we all want to buy things cheaply. In the markets, we want to buy things as they are rising and not a minute sooner.


The art of trading is knowing when something is about to rise and jump on board quickly, or in the case of shorting - sell just as they start falling. 


Markets have a very important aspect to them known as momentum. It is because of momentum, trends can develop and we make money.


Momentum is a trader's best friend.


Now you may wonder what all this has to do with stop orders?.


Quite a lot actually indeed.


Remember I said buy orders are placed above the current price?


The goal of a buy stop order is to catch market momentum as it rises, and not a moment before.


Imagine the price of gold is falling hard, but your fundamental analysis tells you at some point it’s going to rise a lot. 


The last thing you want to do is buy with a market order. It would kind of feel like being run over by a very large bus!


In the markets, traders have another phrase for this - catching a falling knife.


Whether it's the idea of being hit by a bus or catching a sharp knife with your open hand, I hope you can appreciate what can happen if you buy when momentum is against you.


And so this is why we use buy stop orders.


Traders who use them expect at some point, prices will start moving upwards and hit their stop. This will be at the precise time momentum will start increasing rapidly.


What type of strategies are suited to buy stop orders?


You guessed it, momentum and breakouts strategies.



●  Buy Limit Orders


While being on the side of market momentum is always a good idea, it’s up for debate when that momentum is going to change.


Traders who use buy limit orders are effectively taking the other side of momentum or breakout traders. Let me explain.


Buy limit orders are placed below the current market price.


Hold on a mo, you're probably thinking didn't I just say traders like to buy above the market price and catch rising momentum?


Yes, I did, but not all traders!


There is a certain type of trader who does the opposite.


These types of traders are called support and resistance traders.


And they take the opposing side to momentum or breakout traders.


It’s the battle, between these two, that makes the markets so interesting!


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Support & Resistance:Why It Matters

No discussion about stops and limits is complete without talking a little about support and resistance.


The two topics are closely entwined.


There are many ways to define a support line and a resistance line on a chart.  But the general theory behind all of them is, as the name suggests, at support line buyers step and support the price.


At resistance there is heavy selling, so resisting any further price rise.


There are several myths associated with SR  levels. Many of which do not help the budding trader.


A common one is that support and resistance always hold the price. This is total nonsense – because if it were true price would never go anywhere at all!


The fact is sometimes, support holds and sometimes resistance holds. 


Why is the subject so important when discussing stops and limits?


Well.


If you’re going to be using limit orders you’re planning support or resistance will hold.


If you’re going to be using stop orders you’re planning they will fail.


Look at the image below.


This is an example when traders would use buy stops. They would place them slightly above a resistance level and when price breaks that level the order would be triggered.



In the below scenario, we have a support line. Prices will be declining into it and then buyers will be stepping in to buy at support.


This is when you would use a buy limit order in the hope price would move higher.


Sell Stops Vs Sell Limits


These are the mirror opposite of buy stops and buy limits. 


A sell stop is an order that is placed below the current market price, meanwhile, a sell limit is an order placed above the current price.


Both of these orders are used for shorting.



If support breaks we’re using sell stop orders to catch a decline as in the graphic below.

A screenshot of a cell phone

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If resistance holds we are using sell limit orders to catch a reversal in price, as in the graphic below.

A screenshot of a cell phone

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Trailing Stops


I am not going to discuss this in-depth. There is a great article about trailing stops written here. All that is worth mentioning for now is that once you’re in a trade via an advanced entry order you’ll also have the option of using a trailing stop.


The trailing stop will follow your trade into profit. If you’re long the trailing stop will always be below the current price.


If you’re short, the trailing stop will always be above the current price.


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Trailing stop orders on Mitrade platform (Trade Now ➤)

Which Is Best? Stop Orders Or Limit Orders?


I know where I stand on this debate and will give you my opinion, but it’s important to realize opinions are just that.


Each of us must develop a unique method of trading. My style is just one, it's important you find a style that suits you.


With that said, I consider myself a momentum or breakout trader. I like to catch markets as they start moving quickly, in the hope I can ride some of that wave higher or lower.


Because of this, my preference is for stop orders.


But I know many support and resistance traders. They view the market differently than me.


What these traders do to increase their chance of success is to combine their excellent support resistance analysis with overbought/oversold indicators such as MACD or RSI.


When these indicators are at extremes, and when an important support or resistance line is fast approaching, they use buy limit orders and sell limit orders very effectively.


Key Takeaways


This all might seem a bit complex for the new trader, I assure you though with a little practice on a Mitrade demo account it will all become second nature.


What is worth remembering is that with stop orders you have momentum behind you. You are trading breakouts and momentum strategies.


With limit orders, you’re looking to trade oversold or overbought markets. You’re looking to trade reversion to the mean or reversal strategies.


Both have their place in trading, the key for you is to find which suits you best.


If you apply for a Mitrade demo account today you can try both order types and hone your trading skills.


Happy Trading


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The content presented above, whether from a third party or not, is considered as general advice only.  This article does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Mitrade does not represent that the information provided here is accurate, current or complete. Mitrade is not a financial advisor and all services are provided on an execution only basis. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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