What is a Buy Stop Order
A buy stop order instructs a broker to purchase a security when it reaches a pre-specified price. Once the price hits that level, the buy stop becomes either a limit or a market order, fillable at the next available price.
This type of stop order can apply to stocks, derivatives, forex or a variety of other tradable instruments. The buy stop order can serve a variety of purposes with the underlying assumption that a share price that climbs to a certain height will continue to rise.
Key Takeaways
- A buy stop order is an order to purchase a security only once the price of the security reaches the specified stop price.
- The stop price is entered at a level, or strike, set above the current market price.
- It is a strategy to profit from an upward movement in a stock’s price by placing an order in advance.
- Buy stop orders can also be used to protect against unlimited losses of an uncovered short position.
Basics of a Buy Stop Order
A buy stop order is most commonly thought of as a tool to protect against the potentially unlimited losses of an uncovered short position. An investor is willing to open that short position to place a bet that the security will decline in price. If that happens, the investor can buy the cheaper shares and profit the difference between the short sale and the purchase of a long position. The investor can protect against a rise in share price buy placing a buy stop order to cover the short position at a price that limits losses. When used to resolve a short position, the buy stop is often referred to as a stop loss order.
The short seller can place their buy stop at a stop price, or strike price either lower or higher than the point at which they opened their short position. If the price has declined significantly and the investor is seeking to protect their profitable position against the subsequent upward movement, they can place the buy stop below the original opening price. An investor looking only to protect against catastrophic short position loss from significant 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 bullish movement in a security. Another, lesser-known, strategy uses the buy stop to profit from anticipated upward movement in share price. Technical analysts often refer to levels of resistance and support for a stock. The price may go up and down, but it is bracketed at the high end by resistance and by support on the low end. These can also be referred to as a price ceiling and a price floor. Some investors, however, anticipate that a stock that does eventually climb above the line of resistance, in what is known as a breakout, will continue to climb. A buy stop order can be very useful to profit from this phenomenon. The investor will open a buy stop order just above the line of resistance to capture the profits available once a breakout has occurred.Astop loss order canprotect against subsequent decline inshare price.
Example of a Buy Stop Order
Consider the price movement of a stock ABC that is poised to break out of its trading range of between $9 and $10. Let’s a say a trader bets on a price increase beyond that range for ABC and places a buy stop order at $10.20. Once the stock hits that price, the order becomes a market order and the trading system purchases 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 large short position on ABC, meaning that she is betting on a future decline in its price. To hedge against the risk of the stock’s movement in the opposite direction i.e., an increase of its price, the trader places a buy stop order that triggers a buy position if ABC’s price increase. Thus, even if the stock moves in the opposite direction, the trader stands to offset her losses.
FAQs
A buy stop order is most commonly thought of as a tool to protect against the potentially unlimited losses of an uncovered short position. An investor is willing to open that short position to place a bet that the security will decline in price.
When would you use a buy stop order? ›
A buy stop order is most commonly thought of as a tool to protect against the potentially unlimited losses of an uncovered short position. An investor is willing to open that short position to place a bet that the security will decline in price.
What is the point of a stop order? ›
A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes a market order. The advantage of a stop order is you don't have to monitor how a stock is performing on a daily basis.
What is an example of a buy stop limit order? ›
For example, if a trader has a short position in stock ABC at $50 and would like to cap losses at 20% to 25%, they can enter a stop-limit order to buy at a price of $60 and a limit price of $62.50.
Why do people use stop orders? ›
Stop orders may help you obtain a predetermined entry or exit price, limit a loss, or lock in a profit. Stop orders are used most often to help protect an unrealized gain or to limit potential losses on an existing position.
What is the disadvantage of a buy stop order? ›
Cons: Triggered by Volatility: Buy stop orders are triggered by market volatility, which means that they can be executed at a higher price than anticipated if the market moves rapidly. This can result in slippage and potentially higher trading costs.
Under what circ*mstances would a trader use a stop buy order? ›
Buy stop orders are commonly used to take advantage of upward price momentum, potential breakouts, or significant resistance levels. They can be especially beneficial during bull markets when you want to join the upward trend. One of their advantages is that they provide a systematic approach to entering a trade.
Why use a stop order instead of limit? ›
Remember that the key difference between a limit order and a stop order is that the limit order will only be filled at the specified limit price or better; whereas, once a stop order triggers at the specified price, it will be filled at the prevailing price in the market--which means that it could be executed at a ...
What are the advantages of stop orders for customers? ›
Stop orders offer benefits such as limiting losses through stop-loss orders, locking in profits with trailing stop orders, and automating trading with predetermined prices.
Can I reverse a stop order? ›
A stop order is an agreement between you and your bank. You instruct the bank to make a series of future-dated repeat payments on your behalf. You can instruct the bank to cancel the stop order at any time.
Buy Stop Limit
A stop price and a limit price are then set once the trader specifies the highest price they are willing to pay per stock. The stop price is a price that is above the market price of the stock, whereas the limit price is the highest price that a trader is willing to pay per share.
What is the difference between buy stop and buy limit? ›
What is the difference between a Buy Stop and a Buy Limit? With a Buy Stop Order you set the Price higher than the current market price. With a Buy Limit Order the limit price is always lower than the current market price, not higher. In a Buy Stop Limit Order the two work together.
What is an example of a stop loss order? ›
For example, a trigger price of ₹105 and a price of ₹105.10 can be set. When the trigger price of ₹105 is reached, a buy limit order is sent to the exchange, and the order is squared off at the next available offer below ₹105.10. Thus, the SL order may be executed at ₹105.05 or ₹105 but not above ₹105.10.
When to use buy stop order? ›
A buy stop order is an order to a broker to purchase a security at a higher price than the current market price. It means the investor wants to catch a rising trend in a security's price. A buy stop is the opposite of a stop-loss order, which is triggered by a declining price.
Which is typically considered the riskiest type of investment? ›
Equities are generally considered the riskiest class of assets. Dividends aside, they offer no guarantees, and investors' money is subject to the successes and failures of private businesses in a fiercely competitive marketplace. Equity investing involves buying stock in a private company or group of companies.
Do stop orders turn into market orders? ›
A stop order, also referred to as a stop-loss order is an order to buy or sell a stock once the price of the stock reaches the specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order.
When would you use a stop buy order quizlet? ›
To limit the loss, a buy stop is placed to buy in the stock if the market rises to the stop price. Profits on short positions are lost if the market begins to rise from a low point. To protect the profit, a buy stop order is placed higher than the current market.
How to use buy stop and sell stop? ›
You place a “Buy Stop” order to buy at a price above the market price, and it is triggered when the market price touches or goes through the Buy Stop price. You place a “Sell Stop” order to sell when a specified price is reached.
What is the difference between buy stop and sell stop? ›
A buy stop order is entered at a stop price above the current market price. Investors generally use a buy stop order to limit a loss or protect a profit on a stock that they have sold short. A sell stop order is entered at a stop price below the current market price.
