A common question that new traders often ask is if it is acceptable to place a protective stop while simultaneously placing an order to enter on a limit. The trader who typically asks this question is primarily concerned with having a predefined risk parameter for his limit order. The answer to this question is yes, since the market must trade through a limit order before a protective stop loss.
A limit order is an order type that allows a trader to place a trade at a specific price and get filled at either that price or better depending on where the market trades first. To illustrate, if a trader would like to enter the market on a buy limit order, the trader will be filled at either the price they specify when entering the order or a lower price. Buy limit orders are placed below where the market is currently trading.
Another common order type is a stop order. Stop orders are used in two different scenarios. Stop orders can be used as protection on a position that has either been filled or is working. Stop orders may also be used to enter the market on a breakout.
One very common method of trading is to enter the market on a limit order and place a protective stop at the same time to help manage risk by having a predefined risk parameter. Limit orders are filled before protective stops because limit orders are always placed between the market price and the protective stop loss, so the market must trade through the limit price before reaching the protective stop loss price. For example, if a trader places a limit order to Buy 1 March 14 E-Mini S&P at 1844 and would like to place a protective stop to Sell 1 March 14 E-Mini S&P at 1840 the market must fill the trade at 1844 or less before it reaches the trader’s protective stop loss at 1840. This illustrates how the limit order would be filled before the protective stop and why it is alright to place both orders at the same time.
However, if a trader is looking to enter the market on a stop order, the trader must wait until the stop order is filled before placing a protective stop. This is necessary because the trader will be filled on whichever stop order the market reaches first. To illustrate, the E-Mini S&P is trading at 1850. A trader places a stop order to Buy 1 March 14 E-Mini S&P at 1852 in an attempt to enter the market on a breakout to the upside. The trader then places a protective stop at the same time at 1848. In this case, the trader will be filled at either 1852 or greater or 1848 or less depending on which price the market trades through first.
Not only is it possible to enter the market on a limit and place a protective stop at the same time, but it is encouraged to help protect large losses and manage risk. There are many factors that can have a major effect on each futures market at any time. Having a protective stop loss on a current position is important to protect traders from the possibility of losing more capital than one intends to on a trade and prevent them from losing more capital than in the account.
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STOP ORDERS DO NOT NECESSARILY LIMIT YOUR LOSS TO THE STOP PRICE BECAUSE STOP ORDERS, IF THE PRICE IS HIT, BECOME MARKET ORDERS AND, DEPENDING ON MARKET CONDITIONS, THE ACTUAL FILL PRICE CAN BE DIFFERENT FROM THE STOP PRICE. IF A MARKET REACHED ITS DAILY PRICE FLUCTUATION LIMIT, A "LIMIT MOVE", IT MAY BE IMPOSSIBLE TO EXECUTE A STOP LOSS ORDER.
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