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First, I should probably explain what stop limit orders are. Stop limit orders is an order placed with the brokerage (see my Questrade review for more on the brokerage that I use) that combines a stop order and a limit order. Once the price reaches that price that you set, the order will be executed. Here is how to set up a stop limit order in your brokerage.
Pros and Cons of Stop Limit Orders
I've been burned on both sides when I used a stop limit order to protect my investment from a big drop. When I mean burned on both sides, I didn't set a stop limit order one time and faced a huge drop in my investment (nevertheless it bounced back) and another time (or a few times, really) I set up a stop limit order and sold my excellent dividend paying stock when it bounced back really well (and continued to climb for years to come).
The latter example happened when I was on an overseas trip in 2010 and had set my stop limit order for Telus shares. It dropped and triggered my stop limit order while I was away and unbeknowst to me, it triggered a sale of my shares. Since 2010 the shares have climbed and climbed and I had ended up buying back a few shares but only about 25% of what I owned beforehand.
Pros of Stop Limit Orders
For me, the pros of stop limit orders are that I can sleep soundly (or try to sleep soundly) and travel soundly knowing that I have a protective mechanism in place in case the market were to crash or there were to be a large drop in the share price. The ability to set it and forget it takes the emotion and planning out of investing (which is a key aspect to investing). It gives a little bit of piece of mind, however, this piece of mind is not always 100% reliable (as you soon shall see below) and it does not always work in your portfolio's favour.
Cons of Stop Limit Orders
On the other hand, stop limit orders aren't 100% reliable. Although they are meant to reduce the risk, sometimes the market can be crashing so quickly (e.g. the market is so volatile) that even though the brokerage will try and sell your stock, it won't be able to. In the Globe and Mail a reader shares their painful lesson when using stop limit orders.
Another example is when one isn't careful enough to make it a stop limit order and instead makes it a stop order. I can't remember exactly what I did, but it started with my CPD preferred shares. Somehow a sale of all my CPD shares (approximately $45,000) worth was triggered even though it didn't reach my stop limit price. I found out it was because I forgot to put the LIMIT price into the box (a small, careless blunder cost me $1500 in a capital loss… yup, I roll like that a lot of the time!) and my shares got triggered.
Another con is that stop limit orders might not work well for dividend stocks (caveat: good quality dividend stocks). For example, some dividend stocks in my portfolio, I don't put a stop limit order because I ask myself- if the market were to crash, would I sell or would I just load up on more? The answer would be the latter, so I don't put a stop limit order on those specific stocks.
Also, it depends on how much you set your stop limit order at. Some people set it to be less than 15% of the bought share price. Which is approximately what I do. My thinking is that if you can't stomach a 25% drop in your portfolio, maybe investing isn't for you? There will be ups and downs and there will be volatility undoubtedly.
What I Do
After deliberating between the pros and cons of stop limit orders, I do use stop limit orders and I use it for the majority (maybe about 70-80%) of my shares in that particular stock. I opt for about 15% less than the price I bought the stock for and I don't use it for all my stocks. For example, my favourite dividend payers, such as KEG.UN or HSE.TO, BMO.TO or FTS.TO I don't have stop limit orders on them.
2017 Update – I have revised my thoughts a lot about investing over the past few years, and so I'm going back to some of these articles that detailed my learning experience in order to provide some more recently updated advice. You can now learn from my mistakes instead of learning the hard way! Doing a ton of stock research and playing around with options and stop-loss orders is worth it for some people I guess, but just not for me. I've decided over the years to put more and more priority on keeping things simple. As a result, I now recommend basic index investing (aka couch potato investing). If you look in my TFSA or RRSP you'll find these ETFs. For the simplest of all investing solutions – take a look at the options presented by Canada's robo advisors. I've recently taken to recommending robos to many of my friends who are less-savvy in the personal finance realm just based on how easy they are to set up and manage (see our Wealthsimple review for our in-depth thoughts on the largest robo advisor in Canada). I have yet to hear a complaint!
Readers, what do you think? What has your experience been with stop limit orders? Do you use them or do you avoid them?
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