Stop orders can be highly useful tool for investors, and it is import to understand how to use them effectively in your trading strategy. A stop order is a type of order to buy or sell a specified security once a preset price has been reached. With a buy stop order, a security is purchased when a stock price rises to the investor’s predetermined price target, and are most commonly used to limit losses on an open short position.
A buy stop order can also be utilized to lock in profits on a short position, as well as open a new long position for investors hoping to catch a security that will continue to rise in price. It is important to review a but stop order example prior to using this type of order to learn how to maximize the benefits of this valuable tool.
While stop orders and buy stop orders can give investors an advantage when trading securities, there are also potential drawbacks to using this type of order. One must always carefully weigh the pros and cons of these orders, and decide the best strategy for your unique investment goals.
Buy Stop Order Example For A Short Position
In this but stop order example, you can see how to best use this type of stop order to limit losses on an existing short position. When a short position has been opened, you can place a buy stop order that is higher than your entry price to help minimize potential losses in this position.
For example, if you have entered into a short position at $30, you can set your buy stop order (also referred to as a buy stop loss order, or stop loss order for a short position) at $31. When the price of the security rises to your preset price, a market order will be placed to be filled at the next price available.
A buy stop order can also be utilized to protect existing profits on a short position. If you have entered into a short position at $30, and the price of the security has fallen to $25, resulting in unrealized gains, you can then set a buy stop order for the security at a point such as $28.50 to lock in your profits should the price begin to move higher.
Carefully review your trading plan, as well a securities typical trading range in order to determine where to place your buy stop order. Be careful to set your buy stop order at a price that is far enough away for your original purchase price in order to avoid a position being closed due to temporary or severe market volatility.
Buy Stop Order Example For A New Long Position
With this buy stop order example you can see how these orders can be helpful in initiating a new long position. If your trading plan calls for capitalizing on a security’s upward momentum, these types of orders can be very useful. A buy stop order can allow you to buy into a security that is rising in price without having to constantly monitor the stock’s price.
If your research indicates that a security is about to break higher, and you want to capitalize on that upward trend, you can set your buy stop order to purchase the security at your specified price. For example, if a stock is currently trading at $30, and you have reason to believe that the price will move considerably higher, you can set your buy stop order for $32 and hopefully realize profits as the price moves upward.
With this type of order, if your research proves incorrect, or outside conditions cause the price of your specified security to fall rather than rise, your order will not be filled and the position will not be initiated. It is also wise to educate yourself as to the benefits of a stop limit order, to see which type of order is right for you.
As always, there are some disadvantages to using a buy stop order. There is the risk that your order will be triggered by temporary market volatility, causing you to prematurely exit a position only to have the price action reverse shortly afterward. There is also the risk that comes with all market orders that with increased volatility, and/or a large number of orders being filled at the same time, your order may be filled at an unexpectedly high price.
Familiarize yourself with the different types of orders available to you in order to find the best type of stop or buy stop order for your investment goals.