Buy Stop Order – Definition

Cite this article as:"Buy Stop Order – Definition," in The Business Professor, updated March 4, 2019, last accessed October 20, 2020, https://thebusinessprofessor.com/lesson/buy-stop-order-definition/.

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Buy Stop Order Definition

A buy stop order directs a broker to buy a security immediately when the strike price is higher than its current spot price. When the price reaches that point, the buy stop order turns to a market order, and can be employed at the bid price. The market order is applicable to stocks, forex, derivatives or various marketable instruments. The buy stop order plays a major role that assumes a share price that rises to a certain height continues to rise proportionally.

A Little More on What is a Buy Stop Order

A buy stop order is used as a tool to prevent massive losses of an unprotected short position. An investor is willing to gamble on that short position in the hope that the security will decline in price. In case of such a scenario, the investor is prompted to buy cheaper shares so as to have big profit margins among the short sale and sought for a long position. The investor can place a buy stop order with the aim of protecting against a rise in share price so as to cover the short position at a price that curbs losses. The buy stop is often referred to as stop loss order for its role of resolving a short position.

The short seller is allowed to place their buy stop order at a strike price lower or higher than their initial point of opening their short position. In case there is a drastic price decline the investor may opt to protect his profits against future upward movement by placing the buy stop below its initial opening price. An investor with the aim of avoiding disastrous loss from significant upward movement will open a buy stop order above its initial short sale price.

The above described strategies normally use the buy stop so as to protect against a buoyant movement in a security. Another un-common strategy use the buy stop to gain profit from the expected rise in the share price. Technical analysts usually opt for the resistance and support for a stock. The unpredictable price may go up and down but on the high end grouped by resistance and on the low end by support. These are usually referred to as price ceiling and a price floor. Some investors predict that a stock that gradually climbs above the line of resistance is referred to as a break out and, still it continues to climb. In regard to this case a buy stop order is useful in profit making. Therefore, an investor will open a buy stop order just above the price ceiling in order to get available profits once a breakout has taken place. A stop loss order can as well protect against future decline in share price.

References for Buy Stop Order

Academic Research on Buy Stop Order

  • Order form and information in securities markets, Easley, D., & O’HARA, M. A. U. R. E. E. N. (1991). The Journal of Finance, 46(3), 905-927.  This paper investigates the consequences of unforeseen price changes orders on security prices. Its revealed that market makers who is knowledgeable on the types of trades likely to occur will set wider spreads and adjust prices faster than if price-contingent orders were not allowed. Due to the fact that traders have logical assumptions over the book, it is pointed out that unpredictability over the order type minimizes the contrast of prices but in correspondence to a loss in price enlightment. It is shown that the order property of price-contingent orders leads to an increased chance of large price movements.
  • Clustering of stock prices, Niederhoffer, V. (1965). Operations Research, 13(2), 258-265. This study has information which expresses its doubts on the use of random walk model to stock prices. Some of the specialists’ samples in the books show that securities exchange leaders put in their cut off and stop orders at numbers with which they are acquainted to cope with.
  • Order submission strategies, liquidity supply, and trading in pennies on the New York Stock Exchange, Bacidore, J., Battalio, R. H., & Jennings, R. H. (2003). Journal of Financial Markets, 6(3), 337-362. This paper utilizes order data from the NYSE system to carry out a controlled experiment that examines the changes in trader behavior, displayed liquidity supply as well as the execution quality around reducing the minimum price variation to $0.01.
  • Order characteristics and stock price evolution An application to program trading, Hasbrouck, J. (1996). Journal of Financial Economics, 41(1), 129-149. This paper is an econometric investigation of the information contained in the automated orders that arrive at the NYSE. The model catches the joint conduct of robotized orders and furthermore the arrival on the stock record future and the fates spot premise. The outcomes demonstrate that orders contain data helpful in anticipating stock returns past the data contained in the detailed exchanges. Besides, program and file exchange orders contain data past that accessible from the fates return and premise, recommending that these requests are not just aloof transports of basic factor data. Non program, program, and file exchange orders have generally comparable value impacts.
  • Market vs. limit orders: the SuperDOT evidence on order submission strategy, Harris, L., & Hasbrouck, J. (1996). Journal of Financial and Quantitative analysis, 31(2), 213-231. In this paper, the performance measures for market and limit orders are presented. The measures include one for pre-committed traders and another for the passive traders.
  • Secrets for profiting in bull and bear markets, Weinstein, S. (1988). Dow Jones-Irwin, Homewood, IL. This book discusses some successful methods that investors can use for timing investments and continuously produce profitable results.
  • Systematic and random elements in short-term price movements, Houthakker, H. S. (1961). The American Economic Review, 51(2), 164-172. This paper presents a theoretical analysis based on the empirical investigations on the results of particular trading policies in wheat and corn futures and also on the aspects of price changes in the spot and future prices of cotton.
  • Stop-loss orders and price cascades in currency markets, Osler, C. L. (2005). Journal of international Money and Finance, 24(2), 219-241. This paper attempts to prove that stop-loss orders may influence massive, abrupt changes in the exchange rates since they cause rapid, self-reinforcing movements.
  • Traders’ choice between limit and market orders: evidence from NYSE stocks, Bae, K. H., Jang, H., & Park, K. S. (2003). Journal of Financial Markets, 6(4), 517-538. This article presents an examination on a trader’s choice between market and limit orders by utilizing as samples the various orders submitted through NYSE SuperDot.

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