What is a 'Buy Stop Order'
Traders using a buy-stop hope to gain if momentum gains on a particular stock. If the price exceeds the price they have set, it will automatically trigger a market order.
BREAKING DOWN 'Buy Stop Order'The buy-stop order is similar the stop-loss order. The primary reason for using a buy-stop order is to enter into a long position, whereas the function of the stop-loss order is to exit a short position. Both of these actions are predicated upon the trader’s desire to conduct a buying transaction at a price that is higher than the current price. This is somewhat counter intuitive to the “buy low, sell high” cliché that most traders espouse, but there are circumstances in trading that deem it necessary.
Buy High, Sell Higher
There are situations in which traders that utilized technical analysis as a means to make buying decisions may choose to place a buy-stop order at a price higher than the current inside offer. For example, if a market has been range bound for a prolong period of time and the price action is approaching the upper resistance point of the range for the fourth or fifth time, a trader that has a price breakout expectation to the upside and wants to take a long position may choose to place a buy-stop order at a price slightly above the resistance point where confirmation of the breakout is likely. The objective of the trade would be to capture the momentum of the breakout to the next point of resistance.
Another example would be entering a long position based on a double bottom chart pattern. The confirmation/entry point of the “W” shaped pattern is when the price action of the second rebound in the pattern reaches the high of the first rebound. A trader would place a buy-stop order at the high of the first rebound once the second rebound formed.
Adding to a Profitable Position
Another situation that warrants the use of a buy-stop order is when a trader want add volume to an existing long position. Savvy traders will typically add volume to positions that have a sizable profit built up and to which market conditions and expectations are favorable. A price point for adding volume to a long position is determined by proper money/risk management, and market analysis; a buy-stop order is then placed at that price.
Entry Price Slippage
A trader needs to be aware that the price of a buy-stop order is merely a trigger that immediately places a market order. The price at which the buy transaction takes place is not necessarily the same as the price of the buy-stop order. Volatility, liquidity, volume and the size of the trade will all affect the amount of price slippage.