Why Use a Stop Limit Order?

I remember the moment it became painfully clear to me why you would want to use a stop limit order.

It was around 2010 and I was trading a gap system, an earlier version of one that I still trade today.

It involves waiting for a pullback pattern to appear in a stock that’s gapping down, and then entering on a break of the pullback. I was using a sell stop order for the entries.

This worked fine for a couple of years.

Then one day I submitted my sell stop order to enter a trade just as I had done hundreds of times before.

As I watched the chart, waiting for the anticipated move, it suddenly dropped and I heard the familiar ding from my trading platform indicating that I got a fill. Sweet!

But when I looked at my positions for the symbol I was sitting on a huge loss. What the heck?!?

10R of slippage! That’s right – I didn’t get a fill until the price reached a level well beyond what my target was. Ouch.

In that one instant, I realized I needed a better way to enter positions for this strategy.

I now use stop limit orders for the entries for this type of trading strategy.

Here are some tips for using stop limit orders:

  • I calculate the limit price for the order as a percent of the distance to my stop (R). I use 0.24R for the limit price. For example, if the entry price is 50.00, stop price is 49.00, my order goes in with a stop price of 50.00 and a limit price of 50.24 (for a long order). The 0.24 number is not scientific – just a number that seems reasonable.
  • There’s a trade-off using this order type: I sometimes miss profitable trades. That’s the trade-off I’m making to avoid unlimited slippage.
  • I don’t miss as many profitable trades as I thought I would – I was surprised how often the price blows through my limit price without a fill but then eventually comes back to get filled.
  • Because the fill is not guaranteed, I need to have a plan for how long to keep the order active if it goes through my limit price without a fill. This adds some minor, but manageable complexity to the workflow. Experiencing this exact situation was the basis for this article on what to do if you missed a trade.
  • Once I settled on the length of time I wanted the order to be active, I use the Good Until Time on the order in IB so it automatically cancels if unfilled or partially filled.
  • Automation comes in very handy for entering these orders since I have two prices to compute per entry order instead of just one.

Using a stop limit makes 10R slippage a thing of the past.

Using automation for the entries gives you the option to make the orders as complex as necessary without changing your trading workflow.

Leave a Reply

Your email address will not be published. Required fields are marked *