A:

The quick and simple answer to this question is yes.

The major difference between the stop-loss order used by an investor who holds a short position and one used by an investor with a long position is the position in which it is placed. The individual with the long position wishes to see the price of the asset increase, whereas the individual with the short position wants the price of the asset to decrease and would be negatively affected by a sharp increase. To protect against a large price increase, the short seller can use a buy-stop order, which is an order that will turn into a market order once the upper price has been reached. Conversely, the individual who holds the long position can set a stop-loss to be triggered when the price falls below a certain level.

For example, if a trader is short selling 100 shares of ABC Company at $50, he or she might set a buy-stop order at $55 to protect against a move beyond this price. If the price happens to rise to $55.25, the short seller's order would be triggered, resulting in the trader buying the 100 shares back near $55. A word of caution: on an extremely large increase in price, the buy-stop market order could be triggered at a substantially higher price than $55.

A different way that a short seller can protect against a large increase like the one mentioned above is by purchasing an out-of-the-money call option. If the price does experience a move upward, the trader can exercise his or her option to buy the shares at the strike price and then provide them to the lender of the shares used in the short sale.

(To learn more about short sales, see our Short Selling Tutorial. For more on stop-loss orders, read The Stop-Loss Order - Make Sure You Use It.)

RELATED FAQS

  1. How do I set a strike price in foreign exchange trading?

    Learn about the different order types foreign exchange traders can use to manage positions at certain strike prices and how ...
  2. What are common delta hedging strategies?

    Learn about common delta hedging strategies, including how to make a position in options delta neutral by offsetting risk ...
  3. How does being overweight in a particular sector increase risk to a portfolio?

    Learn about the risks of having a portfolio that is overweight in a particular sector and how investors should regularly ...
  4. What are the primary risks an investor should consider when investing in the retail ...

    Learn about the primary risks of investing in the retail sector, such as bad economic conditions, regulation, competition ...
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Strike Width

    The difference between the strike price of an option and the ...
  4. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  5. Reference Equity

    The underlying equity that an investor is seeking price movement ...
  6. Boundary Conditions

    The maximum and minimum values used to indicate where the price ...

You May Also Like

Related Articles
  1. Technical Indicators

    Use the Vortex Indicator Trading Strategy ...

  2. Fundamental Analysis

    How to Create a Personal Risk Management ...

  3. Options & Futures

    Tesla Stock Too Expensive? Trade Tesla ...

  4. Investing Basics

    Want to Beat the Market? Take on Some ...

  5. Options & Futures

    Stock Options To Trade On Intraday Momentum ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!