What Is a Stop Limit and When to Use It?

Like its sibling the stop loss, stop limits are nifty little orders that present a number of particularly attractive features for investors. A tool for mitigating against the losses that present from wayward leveraged positions, stop limits are automatic broker orders that execute trading decisions on your behalf – even if you’re sunning yourself on holiday, at work or out with friends. In the ever-changing world of futures trading, employing a stop limit is an essential part of sensible trading, it can really pay dividends in terms of curbing runaway losses before they gain a head of steam.

A stop limit sets a trigger price point above the purchase price, as opposed to below in the case of a stop loss, at which your open futures position will be liquidated to prevent significant damage to your trading account. While very much a tool for minimising the negatives in this context, the advantages of killing losses before they take hold of your margin and trading account makes this a must-use tool for the prudent, serious trader.

Setting a stop limit runs the same risks as setting any order – that is, that your positioning allows for an unexpected blip in pricing to trigger the closing of your position, often at a loss. Of course, this is something you should seek to minimise by sourcing the best price point for your stop limit.

Price movements tend to by cyclical, and by looking back over a period of time (e.g. a week or a month), you should be able to establish both the high points and low points of recent times. By attempting to understand the factors that led to these price points, you can better get to grips with whether a level is the natural peak price of the futures contract to which it relates – if this transpires to be the case, positioning your stop immediately above or level with that point can provide sufficient security for short to medium-term positions. Naturally, decisions of this nature are all to do with judgement in the particular instance that presents itself, and over time you will become more comfortable with how to position sensible stops.

But it’s not all doom and gloom when it comes to stop limits. It’s also possible to use stop limits to progressively capture profits as they arise, while also leaving the door open for further profits if prices drop further. This strategy, known as the ‘trailing stop’, is implemented by positioning your stop limits at progressively lower levels as prices fall, allowing you to effectively ‘bank’ your gains as they arise. In this vein, stop limits can also be used as a security to store up profits without closing off the potential for even greater gains.

Stop limits and stop losses are designed primarily with the trader in mind, to provide an easy and manageable alternative to manual checking while preventing the total destruction one or two off positions can cause. As trading tools go, it’s one of the more important, and probably one of the central necessary components to any short selling strategy, so it’s advisable to get to grips with how limits work at an early stage so you can implement them in your futures trading strategy.

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