Beginners in forex often miss the difference between placing a new buy/sell order with a stop loss and a limit order. What does each term mean? What is the difference between one another? How to use each of the order types in your favor?
Basically, the variety of order types allows you to be more precise about your trading agenda and the fulfillment of your trades by a forex broker. By placing stop or limit orders, you signal the broker that you are not interested in the current market price. Instead, you prefer to wait until the price moves into a certain direction before your order is executed.
A stop loss order closes an existing trade and prevents the unnecessary losses. When the stop loss order is reached (this happens when the price movement climes above or drops below a specified stop price), the trade is closed at the current market price.
A Stop order becomes a market order as soon as the stop price selected is reached. Thus, for example, instead of losing 100 pips, you lose only 20. Stop loss is rather a term, then an actual order type and the main agenda of a stop loss is to exit a losing trade without having an out of control situation!
The disadvantage of stop loss is that the order not exactly guaranteed to be filled at the preferred price. Once the stop order has been “activated”, it becomes a market order and is filled at the best possible price (and not at the best desired!).
A limit order in forex refers to a "limit" price at which you wish for a trade to be implemented. It is an order of maximum or minimum at which you plan to buy or sell. Limit order is very useful since it guarantees the trade to be executed at a selected price.
The disadvantage of limit orders, however, is that in most cases forex brokers charge quite a commission for limit orders. On top of that, it is possible that your order will not be executed at all, since a limit order only works when your order price (or better) is reached.
Stop Loss VS Limit Order
Both Limit Orders and Stop Loss can be used for either entering or exiting a trading position. However, there are rules:
BUY STOP – placed only above current market price.
SELL STOP – placed only below current market price.
BUY LIMIT – placed only below current market price
SELL LIMIT - placed only above current market price.