What is a buy stop order
A buy stop order instructs a broker to buy a security when it reaches an exercise price higher than the current spot price. Once the price has been reached, the buy stop becomes a market order, which can be filled at the next available price. This type of order can be applied to stocks, derivatives, forex or various other negotiable instruments. The stop buy order can be used for a variety of purposes with the underlying assumption that a stock price that rises to a certain height will continue to rise.
Buy a stop order
Basics of a buy stop order
A buy stop order is generally considered to be a protection against potentially unlimited losses from an unhedged short position. An investor is willing to open this short position to bet that the security will fall in price. If this happens, the investor can buy the cheapest stocks and take advantage of the difference between short selling and buying a long position. The investor can protect themselves against a rise in the share price by placing a buy stop order to cover the short position at a price that limits losses. When used to close a short position, the buy stop is often called a stop loss order.
The short seller can place his buy stop at an exercise price lower or higher than the point at which he opened his short position. If the price has dropped significantly and the investor seeks to protect his profitable position against a further upward movement, he may place the stop buy below the initial opening price. An investor seeking only to protect against a catastrophic loss due to a large upward movement will open a buy stop order above the original short sale price.
Buy stop orders for bulls
The strategies described above use the buy stop to protect against the upward movements of a security. Another, less well-known strategy uses buy stop to take advantage of the expected upward movement in the share price. Technical analysts often refer to the resistance and support levels for a security. The price can go up and down, but it is in parentheses at the top by the resistance and by the support at the bottom. These can also be called the ceiling price and the floor price. Some investors expect, however, that an action that eventually crosses the resistance line, in what is called a breakout, will continue to climb. A buy stop order can be very useful to take advantage of this phenomenon. The investor will open a buy stop order just above the resistance line to capture the profits available once a breakout has occurred. A stop loss order can protect against a further fall in the share price.
Key points to remember
- A buy stop order is an order to buy a security at a specified strike price. It is a strategy to take advantage of an upward movement in the stock price by placing an order in advance.
- Stop buy orders can also be used to protect against unlimited losses from an unhedged short position.
Example of stop purchase order
Consider the price movement of an ABC stock that is ready to break out of its trading range between $ 9 and $ 10. Let’s say a trader is betting on a price increase beyond this range for ABC and placing a buy stop order at $ 10.20. Once the stock reaches this price, the order becomes a market order and the trading system buys the stock at the next available price.
The same type order can be used to cover short positions. In the above scenario, assume that the trader has a significant short position in ABC, which means that he is betting on a future price drop. To hedge against the risk of the action moving in the opposite direction, i.e. an increase in its price, the trader places a stop buy order which triggers a buy position if the price d ‘ABC is increasing. So even if the stock moves in the opposite direction, the trader stands to compensate for his losses.