What is a buy-stop order?
A trader has various options to choose from in customizing a trade. One option is a buy-stop order. A buy stop order is a trader’s instruction to a broker to buy a particular asset at a specific price. When we say “specific price”, we refer to the stop price.
It applies to stocks and other assets that we can trade, such as forex, futures, derivatives, and many more. Furthermore, a trader may want to consider using this type of strategy when they anticipate a price increase in the future.
Traders use this strategy to gain profits when a stock’s price increases and being proactive by placing a buy-stop order early. In other cases, a buy stop order also protects a trader from too many losses due to an uncovered short position. This article will elaborate more on these topics about a buy stop order.
More on buy stop orders
A buy stop order is like a default buy limit order because it buys an asset once it hits a price higher than the current market price. The order will wait until the price reaches the stop price. Later on, it will convert into a market order. Traders do this kind of trade when they anticipate a breakout or a price increase is about to happen.
A trader covers a short position using a buy stop order
Before elaborating more on buy stop orders, let us define first a short position. Traders use short positions when they sell their asset initially, then repurchasing it later at a lower price. The act of buying is also called a cover. Traders usually do this when they anticipate a price decrease in the future and gain profits from it.
Moving back to buy stop orders, traders use a buy stop order to avoid having too many losses due to an uncovered short position. When traders open that short position to bet that the asset will have a price decrease, they can buy cheaper assets. Later on, traders gain profits after selling a short position and buying a long position.
Traders will use a buy stop order to avoid the risk of a price increase and provide cover to short positions.
An example scenario with a buy stop order
Let’s say Rob is observing SH stocks. Later on, he anticipates that a breakout is about to begin due to SH stock’s price movements. They are currently selling at $20 and $21, and Rob firmly believes that an upward trend is coming. He places a buy-stop order at $21.50. As soon as SH’s stock hits $21.50, it will convert into a market order. The system will buy this stock at the next price available.
In another scenario, buy stop orders can also offer a cover on short positions. Say Rob uses a large short position, and he thinks that the price will decline soon. He avoids any risks like a price increase by placing a buy stop order that will buy as soon as there is a price increase. Rob is still secured even if the price declines since it was his bet from the very beginning.