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What is a 'Buy Stop Order'

A buy stop order instructs a broker to purchase a security when it hits a strike price that is higher than the current spot price. Once the price hits that strike, the buy stop becomes a market order, fillable at the next available price. This type of order can apply to stocks, derivatives, forex or a variety of other tradable instruments. The buy stop order can serve a variety of purposes with the underlying assumption that a share price that climbs to a certain height will continue to rise.

BREAKING DOWN 'Buy Stop Order'

A buy stop order is most commonly thought of as a tool to protect against the potentially unlimited losses of an uncovered short position. An investor is willing to open that short position to place a bet that the security will decline in price. If that happens, the investor can buy the cheaper shares and profit the difference between the short sale and the purchase of a long position. The investor can protect against a rise in share price buy placing a buy stop order to cover the short position at a price that limits losses. When used to resolve a short position, the buy stop is often referred to as a stop loss order.

The short seller can place their buy stop at a strike price either lower or higher than the point at which they opened their short position. If the price has declined significantly and the investor is seeking to protect their profitable position against subsequent upward movement, they can place the buy stop below the original opening price. An investor looking only to protect against catastrophic loss from significant upward movement will open a buy stop order above the original short sale price.

Buy Stop Orders for Bulls

The strategies described above use the buy stop to protect against bullish movement in a security. Another, lesser-known, strategy uses the buy stop to profit from anticipated upward movement in share price. Technical analysts often refer to levels of resistance and support for a stock. The price may go up and down, but it is bracketed at the high end by resistance and by support on the low end. These can also be referred to as a price ceiling and a price floor. Some investors, however, anticipate that a stock that does eventually climb above the line of resistance, in what is known as a breakout, will continue to climb. A buy stop order can be very useful to profit from this phenomenon. The investor will open a buy stop order just above the line of resistance to capture the profits available once a breakout has occurred. A  stop loss order can protect against subsequent decline in share price.

 

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