Your average trading platform will have anywhere from a few basic types of orders, to dozens of order types, depending on how advanced of a platform.
One of those basic order types, included even in web-based discount brokerage platforms, is the buy stop order.
What is a Buy Stop Order?
A buy stop order is an order to buy a security, much like the ‘default’ buy limit order. Put simplest, a buy stop is an order to buy a security at a higher price than the current market price.
The order sits idly in the market until the price of the security reaches the stop price, at which point, the order is activated and becomes a market order.
That may sound weird, you may be thinking “if someone wants to buy, why wouldn’t they buy at a higher price?” There are several reasons for that. The most common is that the trader believes that if the market trades above a certain level, a breakout or uptrend is bound to begin.
Another use for a buy stop order is for a stop-loss in a short trade.
When shorting a stock, it’s always smart to have a stop loss, but you can’t use a buy limit as a stop loss because a buy limit order will buy the stock at or below the limit price.
This would stop you out of the trade as soon as you enter it. On the other hand, a buy stop order can be set above your short entry price and only activates when the market reaches that price.
How To Place Buy Stop Orders for Entries and Exits
The most common reason to use a buy stop as your entry point is if the chart doesn’t look strong at the current market price, but if a level were to be cleared, then a good trade opportunity would be created.
The chart below is an example of what I’m talking about.
As you can see, in this scenario, the market has just gapped down after recently reaching a new intermediate-term high. Buying at this point might not make sense, because there are considerable downward short-term momentum and no sign that the selling has cooled off yet.
However, there are a few levels on this chart that might make an interested trader take a position:
- The first is the fill of the gap between $183 and $186.
- The break of the most recent swing high around $195
- The first close above the 5-day simple moving average, around $189
Depending on the trader’s style, a trader would place a buy stop at one of the above levels, anticipating continuation if the price breaches the level. If the market continues to decline, the buy stop wouldn’t be activated and the trader would avoid exposure to the further bearish price action.
Buy stops are also used as exits for short trades. Perhaps you’ve shorted a stock around its resistance level, seeing that the market doesn’t look strong enough to break out.
You might place a buy stop two ATRs (average true range) above the resistance level. This way, if the stock does breakout and show continuation, your buy stop will activate and close the trade.
Example
First, a buy stop order is only executed when the market price reaches the stop price.
For example, let’s assume that the stock/ETF that you’re trading is coming up against a resistance level, and you’re only interested in buying if the stock can break the resistance level.
Take a look at the chart below.
As you can see, the NASDAQ ETF was trading at $56.08 in the above chart, but in this scenario, we’re only a buyer if the price can clear the $60 resistance level.
So, instead of buying in at the market, we place a buy stop order above the resistance level, in this example, at $62.00.
When the price of the ETF reaches $62.00, your buy order will be activated and at that point, you’ll be buying into the market.
Bottom Line
Buy stop orders are one a few basic order types that are available to you on almost any trading platform.
They’re invaluable to swing traders who can see a potential trade setup forming, and want to preemptively ensure that they enter as soon as the setup confirms, without having to watch the market.