A:

To answer this question, let's look at a few different situations. You bought a stock for $10 but want to be able to protect against loss, so you decide you want to enter a sell order if the price reaches $9.50. However, deep down you believe the stock is going up and you want to lock in profits at $11, so you want to enter a second sell order at $11. The problem is, you can't use this strategy.

First thing's first: the order you should be trying to enter for the $9.50 price (to reduce the downside) is a stop order not a limit (or sell) order. This is important because if you enter the order as a limit order for $9.50, it will be sent to the exchange and be filled immediately at the best available price, which should be around $10. This doesn't accomplish the collar strategy you are trying to create.

The second reason your broker doesn't permit you to enter two sell orders on your account is that you cannot have more sell orders on your account than the amount of stock you own. This is to protect you. If the stock you're referring to is very volatile and it hits $11 and then subsequently drops past $9.50 on the same day, you've then effectively short sold the position without properly documenting it as a short sale.

You can't cancel one of the orders after the other has been filled. Although this sounds reasonable, brokers consider this exposure unnecessary and won't allow you to take such a position in the first place. Also, because most of these restricted orders are handled manually by traders, they do not have the time to watch the price of a single stock in order to decide which order is correct and still fill it. There is then no way for them to prevent the unnecessary exposure to risk.

One alternative that some brokerages have provided to increase order flexibility are customizable computer trading platforms. This is software distributed by some active trading discount brokerages to their clients, which allows the clients to enter different orders according to their investing strategies. The loss-prevention/profit-taking is one type of order that can be entered using this platform. The drawback is that the order is only effective while you are connected to the Internet and your computer is running. That is, the software is what monitors the market and will send the appropriate order when necessary; no order is sent to market until proper triggers are met. If there is anything wrong with your computer, then your order won't be executed.

To learn more about online brokerages, see 10 Things To Consider Before Selecting An Online Broker and Start Investing With Only $1,000.

RELATED FAQS

  1. What is a "linear" exposure in Value at Risk (VaR) calculation?

    Learn how the value-at-risk (VaR) calculation is used for portfolios with linear risk as opposed to nonlinear risk, and understand ...
  2. How does the risk of investing in the aerospace sector compare to the broader market?

    Learn how the risk of investing in the aerospace sector compares to the broader market and how investors use this information ...
  3. Do any markets not exhibit asymmetric information?

    Find out why every market possesses information asymmetry, and why this isn't necessarily a huge or insurmountable problem ...
  4. Can small investors buy collateralized mortgage obligations (CMOs)?

    Read about collateralized mortgage obligations and their relationship with small investors, plus what risks small investors ...
RELATED TERMS
  1. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  2. Gross Exposure

    The absolute level of a fund's investments.
  3. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  4. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
  5. Risk Financing

    The determination of how an organization will pay for loss events ...
  6. Captive Value Added (CVA)

    The financial benefit that an organization would gain by using ...

You May Also Like

Related Articles
  1. Trading Strategies

    What To Do With Stocks That Hit All-Time ...

  2. Trading Strategies

    Understanding The Price Vs. Time Equation

  3. Chart Advisor

    3 Commodity Stocks Poised For A Move ...

  4. Personal Finance

    How To Calculate Beta Of A Private Company

  5. Trading Strategies

    Market Timing Tips & Rules You Should ...

Trading Center