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What is a Stop-Buy or a Stop-Loss order?

Example for stop-buy:
  1. Shorted stock at $10.0
  2. Put protective "stop-buy" at $11.0
This means if the stock trades at $11.0 or higher, your broker will buy the shares and "cover" your position. You will lose $1.0/share since you shorted at $10.0

Example for stop-loss:

  1. You bought stock at $10.0
  2. Put protective "stop-loss" at $9.0
This means if the stock trades at $9.0 or lower, your broker will sell the shares and close your position. You will lose $1.0/share since you bought at $10.0

The purpose of protective stop orders is to limit your losses. Note that a stop-buy or a stop-loss order become a "market" order when the "stop" price is reached. A market order is generally risky in stocks that are not very liquid. For example if you are long and bought in at $10 and the price falls to 9.0, your order becomes a market order. If the next offer to buy is at $8.0, your broker will sell your shares at $8.0 since there are no offers at $9.0.

To get around this problem, there is another type of order known as the "stop-buy limit" or "stop-loss limit" order (different brokerages may name these type of orders slightly differently). The idea is to trigger a sell (or buy) when the "stop" price is reached but "limit" the upper (or lower) range of the transaction.

Example for stop-buy limit:

  1. Shorted stock at $10.0
  2. Put protective "stop-buy" at $11.0 with limit at $11.50
This means if the stock trades at $11.0 or higher, your broker will buy the shares and "cover" your position up to $11.50. If the price goes higher than $11.5 he won't. You limit your loss to $1.5 maximum. The risk is that if the price clears $11.5, it may increase indefinitely (nowadays, sky is the limit especially with tech stocks)

Our advice: Shorting stock is for professional and experienced traders only. Don't short if you have not hedged your position by some other means (long in debentures or some other security from the same company).

One more thing: Use stop orders not only to limit your losses but also to maximize your profits. This means, if you buy a stock and its price keeps going up, don't exit but "trail" it with a stop-loss order at about %5 discount to the current price.





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