What is Buy Stops Above
Buy stops above refers to a trading strategy based on an investor’s belief that a stock’s price will accelerate upward once it breaks through a level of resistance. To trade on this belief, the investor places a buy stop order at a price slightly higher than the resistance level. A resistance level generally results from a concentration of sell limit orders at a particular price point. As such, it is an expression of widely-held market sentiment about that stock’s price ceiling.
BREAKING DOWN Buy Stops Above
Buy stops above is a technique based in the technical analysis of stock price movements and the concepts of resistance and its counterpart, support. Resistance and support theory operates on the assumption that a share price is often constrained between an upper barrier, where resistance comes into play, and a lower bracket, where support takes place. These barriers appear on a chart as the line of resistance and the line of support. Both lines are the result of a concentration of limit orders at those prices. On the upper end, investors have placed a disproportionate number of sell limit orders at a certain share price. On the lower, a large number of buy orders create a downward obstacle for the share price.
The buy stops above strategy comes into play as the share price approaches the upper end of the price bracket, known as the level of resistance. As the share approaches that level, those concentrated sell limit orders will be executed. This tends to send the price back downward below that line of resistance. If the price can survive that wave of selling, it will continue upward beyond the line of resistance. The buy stops above strategy is based on the theory that a share price will then accelerate upward. A trader acting on that theory will have a buy stop order in place to purchase shares as soon as the price begins its climb.
Stock Movement Following a Resistance Breakout
The buy stops above technique implies that a stock’s movement beyond the line of historical resistance signals a fundamental re-evaluation of that stock by the market. The original level of resistance suggested a price point at which market supply exceeds demand, placing downward pressure on the share price. Once the price has moved above that line, in what is known as a breakout, it is common for it to remain in that higher range as the market re-evaluates the stock. The former buy stop level may turn into an attractive point for a sell limit order as it can become a level of support in the future.