Stop Orders In Your Stock Market Trading

by Dave Wooding

So we are clear, a stop order is an order that becomes active once a certain price is exceeded. A buy stop order is an order to buy once price exceeds a certain price. Until the price is exceeded to the upside, the order is not active. The opposite applies for a sell stop order. Sell stop orders become active once a price is exceeded to the downside.

There is an important point to consider, one I was not aware of until a stop order of mine was executed. Depending on your broker, “price” can indicate either a transaction that has occurred or simply that the bid or ask occurred at that price level.

How did I figure out this distinction? For a buy stop order I had in, I reviewed the time / sales report for a stock I bought using a buy stop order without a limit. I noticed that my order was the first transaction at that price – which by the way, turned out to be the high price for the day. My understanding at the time was that a stop order does not become active until another transaction occurs at that price.

Not true according to my broker. Their explanation of why my order was filled was that the asking price tripped the buy stop level I had set. Once that occurred, my order automatically became a market order to buy. Fortunately for me, the trade ending up being a winner. The lesson was learned, make sure you understand how orders work, in particular stop orders.

A way to enter a stock as it starts to move in the anticipated direction is to use a stop order with a limit. For example, if you are interested in buying a stock but you want to wait until the stock “proves” that it is moving higher, you can place an order to buy at a price higher than the current market price and specify the maximum price you are willing to pay. Assume that the current price is $45.51 and you are interested in purchasing this stock if it trades above yesterday’s high of $46.14. You could place a day order to buy 1000 shares on a stop at $46.15 with a limit of $46.21.

If your method of trading uses previous highs and lows as entry points, then using a stop limit order like the one described allows you to place an order when the market opens and not have to watch the screen all day. Additionally, if your stop order becomes a market order to buy, then you have a limit to what you are willing to pay. The $0.05 difference between the stop price and the limit price gives you a little “wiggle” room for getting a fill.

Stop orders can be used to close profitable positions without giving back much of the profits. If you are in a profitable long position, then using a trailing stop below the previous day’s low or the three day low can keep in you a profitable position.

Finally, a stop order can be your best protection from catastrophic losses. It is not a bad idea to place a stop order to exit a position once you enter a stock position. If you are a buyer of a stock, then placing a sell stop order either a certain percentage or below a significant low, can minimize your losses.

Use stop orders in your trading to minimize losses and protect profits. Contact your broker for clarification on the types of stop orders they allow.

Article Source: EzineArticles.com/?expert=Dave_Wooding

Published under category : Stock Trading