Limit Stops Can Help You Avoid Bad Fills on Gaps

  1. You have a GTC sell stop, and bad news is reported on the company outside of regular trading hours, and the stock gaps way down at the open the following day. If the gap down is an over-reaction to the news, then you may wind up selling at the extreme bottom. I use Limit Stops on sells to avoid this situation. If the stock gaps down significantly on the “shock value” of a news story, I want to see it reacts after the gap down. Often, it will partially recover, and I can get out at an improved price, especially if it has gapped down to a level of strong historical support.
  2. You have a GTC buy stop order designed to buy on a price breakout above a trading range. Great news is reported for the company, and it gaps up to a MUCH higher level than it was trading at. For example, a company may announce its intention to buy the company at a significantly share price than the currently trading price. This will generally cause an immediate gap up in price to a level near the purchase offer for the company. Once this gap up has occured, you generally have lost your potential to profit of a breakout, and in this situation, you may prefer that your trade NOT be executed.
  3. A large trade occurs, causing a large single spike in the price up or down, triggering your stop. Since all the buys/sells to the bottom/top of the spike have just been taken out, your order may get filled at the bottom or top of the spike. Limit Stops help you avoid this situation and may result in improved price for your trade. A second technique that helps avoid the consequences of a single large trade causing a price spike is setting the Stop Trigger = “Double Trade Tick”, rather than allowing a single tick to trigger the stop.
  4. For lightly traded stocks, your buy or sell order may run the price up or down if there are few sellers/buyers atthe time your stop is hit. This type of order limits the price you buy or sell at to a value you specify. For lightly traded stocks, you may also wish to consider using the “NO DISPLAY” option, so you do not reveal to others exactualy how much your are willing to buy or sell at. The reason I favor is “NO DISPLAY” in this situation is if others see your posted price on a partially filled order, they will step ahead of you with their bids/offers to be filled before you will. Advertising your limit price encourages others to increase/decrease their bids/offer to buy/sell ahead of your price.
  5. How is “lightly traded” defined? It is relative to your trade size. For example, if I place a trade that represents more than 0.1% of the total amount of that stock traded in a single day, then I consider that stock “lightly trading” compared to MY position size. In this situation my trade may transiently affect the price significantly, and a Limit Stop may be especially useful. If my trade size is less than 0.1% of the daily amount being traded, then there is generally more than enough liquidity for me to get good performance from a Stop Market order instead.
  6. The downside to using Stop Limit orders, is that in a fast moving market, if your limit is not significantly far away from your stop level, then the market may pass your limit price without a complete fill, and you may have to execute your trade at more unfavorable price later.