Ask TheStreet: Limits and Losses

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I am new to trading and do not understand the difference between a stop limit and a stop loss. What is the difference between the two order types and when should each be used? Thanks, A.Y.

Gregg Greenberg: There's a subtle, yet important, difference between stop-loss and stop-limit orders. And it matters most when things, as they occasionally do on Wall Street, get a little out of control.

A stop-loss order becomes a market order when a security sells at or below the specified stop price. It is most often used as protection against a serious drop in the price of your stock.

So let's say you own stock XYZ and it is trading at $20. It's a volatile stock, so you put a stop-loss order on at $15. That means that if the stock falls to $15 or below, your order becomes a market order and will be sold immediately at the best available price.

In theory, XYZ could be sold above your stop-loss price of $15 if the stock touches $15 and then rebounds. Or it could sell well below your stop-loss price at, say, $14, if the stock keeps cratering in a fast-moving market.

Now, you might not have wanted to sell the stock unless it went below $15, but you are out of luck, because you put in a stop-loss order, not a stop-limit order. A stop-limit order becomes a limit order -- not a market order -- when a specified price level has been reached.

That means if XYZ touches $15 in a fast-moving market, triggering the stop, then it will have to hit $15 again (the limit) for the order to be executed.

It's worth noting that XYZ could also open below $15 if some really horrific news is announced before the market opens. Let's say the stock opens at $12.50. In that case, a stop-loss order immediately turns into a market order and will be sold around the $12.50 price.