Forex traders like many other traders, trade with the sole intention of making large profit margins.
However, forex trade is compounded with leverages that can lead to investors making huge profits or sinking into great losses.
For this reason, traders employ a trading strategy to manage their positions in the market.
These include the buy stop and buy limit orders.
And knowing when to use a buy stop vs a buy limit can make life easier in forex trading.
Forex buying and selling are executed using orders.
This is the offer you send using your broker’s platform to open or close a transaction.
The offer contains specific instructions informing your broker how you want the trade to be executed.
More often than not, one is confused for the other. So, what is the difference between buy stop and buy limit order in forex?
What is the difference between a buy stop vs buy limit?
I know you are eager but first, let us explore some order types in forex in order to place our giant in the house in perspective.
Market order: executed against the best available price, provided by your broker
Pending order: executed only when your specified price is reached. Pending orders can further be broken into buy limit, buy stop, sell limit and sell stop.
Buy stop –this is a price that is placed above the current market price. It is a stop price intended to ensure profit is protected on a stock that has been sold or for the purpose of limiting loss.
Buy limit –this is a specific price placed on a currency or security that limits the price at which it will be sold. Buying of the stock can only, therefore, be executed at the limit price or lower.
Well, this may seem complicated.
I will break everything down to smaller bits you can understand and relate.
So, step by step;
A buy stop is triggered when a buy stop order is placed and reached.
A buy stop order will only be executed when the price reaches the specified stop price.
The stop price, therefore, has to be set above the market price, in which case is the price provided by the broker.
We can simply call this stop price.
When you place a stop order, the security you want to trade will only be triggered when the price reaches a particular level.
A buy limit order, on the other hand, can only be executed at the set specified limit price or lower.
A limit order requires you to have an idea of your desired profit margin should the trade be favourable.
Example/ illustration of a stop order and limit order
To make it even simpler, let us look at the illustrations below;
An investor wants to buy a currency pair from a particular stock.
Assuming that the currency pair is priced at $1.020 currently (this forms the market price) and is moving upwards.
You place buy stop at $1.030 in anticipation that the price will continue in the upward trend.
You, therefore, would not need to sit in front of your computer waiting for your anticipated price to be reached. You can place the buy stop order and go for a morning run.
For a buy limit, if a currency pair is trading at $1.020, you would place a limit order to buy at $1.010.
In this case, your order will not be executed until the market price hits $1.010 or lower.
In a very volatile trade environment, where the price goes down to 1.015 and shoots up, your order will not be executed and you may miss an opportunity for a better selling price.
Characteristics of a buy stop order vs buy limit
Buy stop
1. The order is placed above the market price
2. Buy stop order is executed when the current price continues to rise beyond the buy stop price
Buy limit
1. Is placed at or below the market price
2. Buy stop limit is only executed when the market reaches the limit price or goes below the specified price.
3. Execution only happens when the price becomes more favourable to you.
How to execute a buy stop/buy limit
Place a buy stop when you want to buy at a price above the market price
Place a buy limit when you want to buy below the market price.
After identifying the trend, you wait for possible breakout resistance and place your order just near the resistance turned support.
Benefits of a buy stop order/ when and why stop orders to use/ when to consider placing a buy stop order
1. Let us be honest, it is not always that you will be seated behind your computer to monitor the forex market trends. In this case, buy stop and buy limit comes in very handy.
Placing a buy stop order will help you to continue trading without necessarily having to constantly monitor the trend.
The order will execute the purchase at the specified price.
In this case, you will only need to furnish your broker with the specific details of the order you want to place.
2. With a stop order, you can limit or minimize your losses.
Loss management is very crucial in any business.
I know you must be asking yourself how this order can be used to minimize losses.
Let’s say you have already set a buy stop order for your shares, your position will automatically close when the price is reached.
3. Wouldn’t you want to safeguard all your profits?
I know you are wondering why I’m asking an obvious question.
Yes, a buy stop can safeguard your profits gained once the trade becomes profitable.
Remember a buy stop is placed above the market price.
You can move your buy stop price to the profit zone to ensure that you protect your profits in the trade.
Benefits of a buy limit
1. You are guaranteed to pay lower than the market price.
The even better news is that if the price falls below the buy limit price then you trade for an even cheaper price. Great, right?
2. A buy limit offers an investor a definite entry position.
The trade is not executed until the price drops below the limit price, which is lower than the market price.
3. In cases if volatility in the market, buy limit is very handy.
Volatility in the market is essentially market instability posed by frequent rapid changed in price.
Assuming the market closed at $1.020 and an investor places a buy limit of $1.020 in anticipation of a lower start the next day, yet the market opens at $1.025 the order will not be executed.
This will have saved the investor from paying more than they were willing to.
The downside of buy stop vs buy limit
In the case of a buy limit, there is a possibility of you missing on great opportunities.
The order will not be executed if the market price does not reach your market price.
So a slight fall followed by a sharp rise in market price will not benefit you if it didn’t reach your limit price.
What to consider when placing a buy stop order or buy limit order
The most important thing you will want to consider is the trades resistance level.
You don’t want your price to fall far too high or lower than the position of resistance level.
Bottom line
As a forex trader, you should not be too strict with price limitation.
The price stop you place should allow you to maximize on profits and offer protection against huge loss margins.
Both the buy stops and buy limit offers you the liberty of being in control over the market price levels.
By placing the order at which your trade will be executed, you have the liberty of trading without constantly monitoring the market.
You must be asking, so which is better?
No one is better than the other.
It is prudent to have a wide knowledge of the two orders so as to precisely achieve your trade goals.
Proper execution of the two is very important.