Using a Buy Stop Order

A Buy Stop Order is most commonly explained as a method to minimize a loss on a Short Position. Taking a closer look though, you will see that it has another use.

First, let's review what a Stop Order in general is: "An Order to Buy or Sell a Security once a specific price is reached."

Once the specified price is reached, you're order becomes a Market Order to be executed at the next available price.

As I mentioned above, typically you will read that a Buy Stop Order is used as a method to help minimize losses on a Short Position but let's look a little further at its various uses:

  • To help minimize losses on an open Short Position.
  • To Protect profits on an open Short Position.
  • To initiate a new Long Position.

You can see that I highlighted the third use above because you will rarely hear about this one for some reason. Let's take a look at each one in more detail: (Also read about using a Sell Stop Order here)

To Help Minimize Losses on an Open Short Position

Buy Stop Order- Minimize Losses

Once a Short Position is opened, a Buy Stop Order can be placed above your entry price to help minimize any losses you may have.

This is the most common use and often you will see this as a "Buy Stop Loss Order" or "Stop Loss Order" (for a Short Position) on certain trading programs when you enter the order. Other programs will actually state "Buy Stop Order".

They all mean the same thing, once the specified price is reached, your order becomes a Market Order to be filled at the next available price.

To Protect Profits on an Open Short Position

Buy Stop Order- Protect Profits

Again, another method to help manage an existing position. In this case, once unrealized profits are obtained, a Buy Stop Order can be placed at a point to help protect those profits should the security start moving against your position.

If you had an initial order as above to help minimize losses, once profits are available you could adjust the order price to a point as shown to help protect profits.

If the security begins to move against your position and reaches your specified price, it becomes a Market Order to be filled at the next available price.

To Initiate a New Long Position

This is the use most often overlooked. To understand how this can be used to initiate a new long position, take a look at the following example:

Buy Stop Order- Long Position

XYZ stock has moved higher from $2.00 to $4.00 over the last several months. For the most recent 2 weeks, XYZ has traded sideways in a trading range, forming a base between $3.50-$4.00.

You feel that XYZ has the potential to move higher and would like to be able to take advantage of this but only if XYZ does indeed breakout of its current trading range.

Instead of having to monitor XYZ every day, you can place a Buy Stop Order at $4.10 (for illustrative purposes only). Now, if XYZ does indeed breakout of its trading range of $3.80-$4.00 and start moving higher, your order will be triggered once the price reaches $4.10 and become a Market Order to Buy shares of XYZ.

If XYZ does not breakout and move higher, but instead begins to decline and move lower, your Buy Stop Order would remain unfilled.

So, an advantage of using a Buy Stop Order to initiate a new Long Position is that you don't have to monitor the security to determine if it will indeed move higher. This is a great way to try and catch a move based on an expected move after doing research over the weekend or in the evening.

For example: say you recognize a particular pattern forming and expect a breakout of the pattern soon. You can place the Buy Stop Order ahead of time to try and catch the move if it evolves.

As with everything in life, there are disadvantages as well. Your order can be triggered by a short term fluctuation in the price of the security, only to reverse shortly afterwards. Also, since your order will become a Market Order, increased volatility on a breakout can mean having an unexpected fill price due to a large number of other orders being filled near the same time as yours. This can happen with any Market Order.

Things To Consider

  • Make sure the security has enough average daily volume so that wide price swings due to lack of buyers and sellers don't cause unexpected outcomes.
  • Learn about using Stop Limit Orders as well to determine which is better for your situation.
  • Learn about using other types of Conditional Orders such as "One Triggers the Other" (at some brokers) which in this case can automatically enter a Stop Loss if your Buy Stop Order is filled to initiate a Long position.
  • Your Broker may not accept Stop Orders for certain securities so be sure to check first. Not all securities are eligible for Stop Orders and different Brokers may have different guidelines.

Related "Buy Stop Order" Pages on This Site:

Return From "Buy Stop Order" To "Stock Trading Risk Management"

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