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In this article, we will explain what the Buy Stop concept is.
When trading in the financial markets, there are basically two ways to open a trade – immediate execution and pending order. With a pending order, your trade is opened as soon as the market reaches the level you have selected.
A Buy Stop order can apply to stocks, derivatives, forex or a variety of other tradable instruments. A buy stop order can serve a variety of purposes with the basic assumption that a stock price that climbs to a certain level will continue to rise.
Buy Stop is placed above the current market price.
A buy stop order is most often considered as a tool to protect against potentially unlimited losses of an uncovered short position. The investor is willing to open this short position to bet that the price of the security will fall. If this happens, the investor can buy the cheaper stock and profit from the difference between short selling and buying a long position.
A short seller may place his Buy Stop at a Stop Price or Execution Price either lower or higher than the point at which he opened his short position. If the price has fallen significantly and the investor is trying to protect his profitable position from a subsequent move up, he can place a Buy Stop below the original opening price. An investor who is merely trying to protect himself from a catastrophic loss from a significant move upward will open a Buy Stop order above the original short sale price.
We use it most often when we want to trade breakout resistance and speculate on a continuing trend.
Example of a Buy Stop Order
Imagine an ABC stock price that is ready to break out of its trading range between $9 and $10. Let’s say a trader bets on a price increase above this range for ABC and places a Buy Stop order at $10.20. Once the stock reaches that price, the order becomes a market order and the trading system buys the stock at the next available price.
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