Trailing stop limit orders

The best passive order execution risk management money can buy


trailing stop limit order


If you understand stop order and limit orders, then you can understand stop limit orders. And if you understanding trailing stop orders, then you can understand trailing stop limit orders. A trailing stop limit order just adds a limit to a trailing stop order. You use this order simply when you want to use a trailing stop order to lock in as much of your return as you can, but you also want to attach a limit to it, just to avoid being gapped.


Typically, this order is used when you already own a security. You might have bought it months ago or thirty seconds ago. What you’re trying to do now is manage your potential loss. This type of order requires two price inputs – the amount you want to use to trail the current price, and the limit offset. The trailing amount is an amount in relation to the current price. If the current price is $56, you might set a trailing amount of $2. This means that if the price of the security drops by $2 to $54, the order will convert and be available to be executed. Convert to what? Unlike a trailing stop order, it doesn’t convert to a market order. Instead, it converts to a limit order. With what limit price? Unlike a regular limit order, we don’t enter an absolute limit price (like $52). Instead, we enter an offset. This is the offset to the price once the trail is triggered. So, in this example, with a $2 trailing amount, and a price now at $54, our limit kicks in. A $1 limit mean that our limit order is at $1 below (because we’re selling) the current price – $53. This means our order is in the market as a limit order at $53, and won’t execute below that. We must receive $53 per unit, or the order will go unfilled.


And the purpose of all this? If you bought $VT at $50, watched it rise to $56, and then entered that trailing stop order, you’ve ensured that your order will convert to a limit order once the price drops by $2 (the trailing amount), but with a limit $1 below the triggered trailing amount ($53). You’ve ensured a gain of $3.


In some circumstances you might use a trailing stop limit order to buy. One case might be where you want to automatically cover a short, but without buying at too high of a price. However, frankly, we’d find this a bit odd. Because losses on shorts are potentially infinite, the covering short seller is probably better off to just fill that order as soon as possible, without worrying about gapping. But let’s avoid going into too much detail here – you can learn more about shorting (and a better strategy for accomplishing the same thing with a lot less risk) in other articles.

There is a risk with a trailing stop limit order of having your order blown through without being executed. If the stock gaps down at the opening of trading, it might not get executed. So we try to set limits that are wide enough for us to be comfortable with. There are always extreme scenarios – even with a trailing stop limit order in place, owning $LNKD on February 4, 2016 might have meant being stuck with shares worth far below what you paid. This is the chance you get when you trade aggressive growth tech stocks in bearish markets around earnings season. A diverse portfolio suffers less from this risk, to the point that it’s immaterial.


Wrapping it up – a final look at the right order types for the average investor


We’ve covered most of the order types that Questrade (and most other discount brokers offer): market, limit, stop, trailing stop and trailing stop limit orders. Here’s our thinking on which make the most sense for most investors.


If we’re buying a security, we prefer to use a limit order. This ensures we get the security for a price we think is fair, and if the price rises too quickly on us, we don’t buy it at all. There is a chance of only getting part of an order filled and messing up your asset allocation strategy. In this case, you’ll want to enter a second order for more. Trying to get 1,000 shares of a stock trading at $60.01 with a limit order of $60.01 when the direction of the price is upward might not make much sense when the ask size is 50. You’ll get those 50 shares, but the next ask might be $60.02. You would also pay an excessive commission in this case, most likely. But intelligently pricing your order in the first place can avoid this. So the limit order makes a lot of sense when buying.


When selling, we like trailing stop limit orders. The reason is simple – you get to keep as much of your positive return as is reasonably possible, while avoiding giving too much back when prices fall.


There is one huge footnote we want to add to the subject of order types. Thinking about order types is, by and large, an issue for investors making active bets on specific securities. If you are a passive investor happy to receive the market return, you don’t need to worry about this. Buy the portfolio you’re comfortable with and hold it “forever.” You don’t really need limit orders on highly-liquid broad market ETFs. You also don’t need to enter “good until canceled” trailing stop limit orders on these ETFs. If you’re a passive investor, you’re happy with the market return. Don’t try to time the market, don’t try to trade swings or trends, and don’t sweat the pennies. As we’ve detailed in other articles, in the long term, you’ll probably do better than the people who do anyway.

Market Order

Limit Order

Stop Order

Stop Limit Order

Trailing Stop

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