A:

To answer this question, let's look at a few different situations.

A Sell Order Scenario 

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 that 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. Why not?

Stop Orders versus Sell Orders

First things first. The order you should be trying to enter for the $9.50 price (to reduce the downside) is a stop order and 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 limitation is designed to protect you.

If the stock you're referring to is very volatile, for example, and hits $11, and then it subsequently drops past $9.50 on the same day, you have then effectively short sold the position without properly documenting it as a short sale.

Preventing Unnecessary Exposure to Risk

At the same time, 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, as most of these restricted orders are handled manually by traders, they don't have the time to watch the price of a single stock in order to decide which order is correct—and then still fill the order. There would then be no way for them to prevent your unnecessary exposure to risk.

Customizable Computer Trading Platforms

One alternative that some brokerages have provided to increase order flexibility is the option of 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.

Loss-prevention/profit-taking is one type of order that can be entered using this platform, but 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 the proper triggers are met, and so, for example, if you run into Internet connectivity issues with your computer, 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.

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