A buy stop order is traditionally used as a means to limit losses on an open short position, although these types of orders can be useful in a variety of circumstances. A stop order is an order to buy or sell a security when a preset price has been reached.
With a stop order, when the preset price has been reached, it becomes a market order, and will be executed at the next available price. A buy stop order allows an investor to secure an asset if and when the market price begins to rise, without having to monitor the security’s price constantly.
There are distinct advantages to utilizing a buy stop order, including the comparatively low amount of risk associated with these types of orders. Buy stop orders can be used to minimize losses and protect profits on an open short position, and can also be an effective way to initiate a new long position.
Using Buy Stop Orders To Minimize Losses And Lock In Profits On An Open Short Position
A buy stop order is most commonly used to minimize loss on an open short position. When a short position is initiated, a buy stop order may be placed above your entry price. If the specified price is reached, your order will turn into a market order and will be filled at the next available price.
A buy stop order can also be used to manage an existing short position, and lock in unrealized profits. If you have obtained unrealized profits on an open short position, you can place a buy stop order at a point to assist you in protecting those gains in the event that a market reversal causes prices to move against you.
If you have an existing buy stop order in place to protect your position from losses, you can adjust the order price as needed once profits become available. The buy stop order will become a market order if the security were to begin to move against your position and reaches your preset price.
Using A Buy Stop Order To Start A New Long Position
You may also wish to use a buy stop order to begin a new long position, as part of an investment strategy that includes momentum investing. If your research indicates a potential breakout for a security, and your plan calls for investing in this type of momentum, a buy stop order could be a valuable tool in initiating this new position.
If you use a buy stop order to enter into a new long position, you can position yourself to catch unexpected market moves with out having to monitor a security on a constant basis. If a security moves upwards to your predetermined price, then the order will automatically become a market order.
On the other hand, if the security in question does not rise in price, but instead moves lower, the order will remain unfilled, and the new position will not be initiated. A buy stop order can be particularly useful if you have noticed a trend in a security when the market is closed, and would like to take advantage of a security’s potential upward momentum.
Be careful to note if a security has enough daily average volume, as a lack of buyers and sellers could result in wide price swings and unpredictable outcomes. Always weigh potential risks and benefits to these and other types of orders to decide which one is best for you and your investment objectives.