8.4.4.3.4. Stop-Limit Orders
One disadvantage of a sell stop-loss order is that if a stock has gone into a free fall, the investor may end up selling his securities at a very low price once the trigger price has been passed. To prevent this, the investor could instead enter a stop-limit order. Stop-limit orders are orders that become limit orders after the market passes the trigger price. Thus, a stop-limit order involves two prices, the trigger price and the limit price. An investor would use a sell stop-limit order when he wants to protect against a downward trend in a long position but wants to put a limit on how low he is willing to sell his stock for. If the stock passes the trigger price and the next available price is below the limit price, the order will not be executed. Buy stop-limit orders are used to protect short sale gains, and they also protect the investor from purchasing the stock at a high price if there is a sharp increase in the stock price.
Sell stop-limit orders and buy stop-limit orders are not always filled. Buy limit orders will be reduced by the amount of the dividend on the ex-dividend date (see later in the chapter for a definition of the ex-dividend date).
Example: Mary is long 1,000 shares of Candy’s Candy Inc. She likes this stock and has already made a nice profit on it. But she has read in the paper that a new study has come out criticizing Red Dye 76, a dye that is used in a lot of Candy’s Candy products. Mary is worried the stock could start declining and then go into a free fall. To protect her gains, she places a sell stop-limit order @ 40, with a limit of 35. The bid-ask spread for Candy’s Candy is currently 42.13 – 42.15. If the price begins to fall, the sell stop will automatically be triggered if the bid price hits $40. Once the stop price is triggered, Barbara’s order will turn into a limit order with a price of $35. If the stock goes into a free fall, Barbara’s shares will not be sold at