What is Buy-Stop Order?
A buy-stop order refers to an order to buy a security at the market price once the security price reaches the predefined stop price. It’s a type of stop order normally used to limit losses or protect a profit on security that is sold short.
The stop order techniques are popular in stocks, derivatives, and forex markets. In the case of stocks, a stop order from the investor instructs the brokers to buy or sell a stock at the market price once the stock has reached the specified stop price. Other stop orders include sell-stop orders, stop market, and stop-limit orders.
Table of contents
- A buy-stop order is placing an order to buy a security at the market price, and the order gets activated only when the security price reaches the stop price specified in the order.
- It is used to reduce risk, limit the losses or protect the profit associated with a position.
- It is a popular technique among investors in the stock market, foreign currency, and derivatives market.
- If a stock is trading for $33 per share and technical indicators hint at an uptrend, the investor can place a buy-stop order at $34. If the price reaches $34, the order gets executed and becomes a market order buying the stock at $34 if available or the next price.
Buy-Stop Order Explained
In the buy-stop order, the process gets started with the investor placing the order with the broker, and the broker directs the order to the exchange, regional exchange, or third market makers. If the security price reaches the stop price, the order gets executed at the market price; hence it becomes a market order. At the same time, the order becomes void if the stock price doesn’t reach the stop price.
The technique is used in different scenarios. One of the common applications occurs when it is used to buy a stock at a profitable price anticipating an uptrend. For instance, the investors can place the order to buy by picking a strike price just above the resistance line; if the stock moves above the resistance level, a breakout occurs, the order gets executed, and the investor can gain from a price surge and increase in demand for the stock.
Another apt use of strategy occurs in short position cases. Short selling involves the borrowing shares of stock and investors profiting from falling prices. An unexpected price rise will affect the profit in this scenario, and using this stop order technique in such a scenario helps the investor (short-sellers) limit losses or protect a profit on the stock that they have sold short. For example, if the stock is in a downtrend and the price decrease is at its maximum, the investor can place the order to buy to lock the profit. Whereas, if an uptrend is anticipated or the price starts rising after the downtrend, the investor use this stop order to limit the loss due to the price rise.
Buy-stop order technique is often compared with other stop orders:
- Sell stop limit order exemplifies a combination of stop-loss order and limit order. It involves stating a stop price and a limit price below the current market price.
- Buy stop limit order is used to purchase stock before it crosses a specific price point. The technique involves setting a stop price and a limit price. In this case, the stop price is a point above the current market price, and the limit price is the highest price investor willing to pay.
- A sell-stop order is executed at a stop price below the current market price. Investors generally use a sell-stop order to limit a loss or protect a profit on a stock they own.
- Furthermore, traders also use trailing stop orders as a risk management technique.
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Jacob has been into stock trading for a reasonable time now and has been eyeing a particular stock that he believes has great potential to break out from its current price circuit. Currently, the stock is trading for $5 per share. Sources like stock price charts disclose $6 as the current resistance level and $3 as the current support level. Jacob puts a buy-stop order at $6.10, meaning that he has placed an order to buy fifty shares of the stock in advance if the stock reaches the price of $6.10 per share. The moment the stock reaches the price of $6.10, the order gets executed and becomes a market order buying the stock at the next available price, like purchasing at $6.10 or $6.20 per share.
Frequently Asked Questions (FAQs)
If a stock is trading at $15 per share, the stop price and the limit price will be a price above the current market price, like a stop price of $17 and a limit price of $18. The order is activated when the price reaches $17, but there will be no order fulfillment if the price moves above $18.
If the current stock price is $15 per share, the stop price and limit price should be below the current market price, like a stop price of $10 and a limit price of $7. The order is activated when the price falls to $10, but there will be no order fulfillment if the price drops below $7.
A stop-loss order, also known as a stop order, is used to limit losses. Under this technique, an investor places an order to buy or sell a security when it reaches a specific price. When the stock price reaches the predefined price, the order becomes a market order and gets executed. In the case of long positions, placing a buy order at a specified price can be used to reduce losses due to unexpected price drops. In case of a short position, the investor profit from falling prices. If a trend reversal or an uptrend is anticipated or starts to emerge, the investor can place an order to buy to limit the losses due to price rise.
This has been a Guide to What is Buy-Stop Order. We explain its definition, examples, stop loss buy order, buy stop limit order, sell stop limit order, etc. You can learn more from the following articles –