Don’t be fooled by the word “stop” in the term “buy stop.” It doesn't mean to stop buying; it means to start buying once the security’s market price reaches the stop, or trigger, price.
An investor can use a buy stop order for different financial assets, including stocks, exchange-traded funds, currencies, and derivatives.
What is a buy stop order?
A buy stop order is an order to a broker to purchase a security at a higher price than the current market price. It means the investor wants to catch a rising trend in a security’s price. A buy stop is the opposite of a stop-loss order, which is triggered by a declining price.
How are buy stop orders used by investors?
Buy stop orders tend to be used in two ways:
- To limit investors’ losses from a short-sale strategy that went awry.
- To invest in the early stage of an expected rise in the stock’s price.
In a short sale, investors borrow shares from a lender (brokerage, bank, etc.) for a certain period of time, and sell the shares in the open market. They bet the price will decline in the time period, and they can buy the same number of shares at a lower price before returning them to the lender. They would profit from the difference between the sale price and the cheaper repurchase price.
On the other hand, if the share price starts rising, that can diminish or erase investors’ short-sale profit. They could be exposed to large losses if the market price climbs above the short-sale price. To lock in some profit, they could place a buy stop order with a broker at a price below the short-sale price.
Buy stop order example: Short selling
Amazon Inc.’s recent stock price history provides a good illustration of a short-selling opportunity and how a short seller might use a buy stop order. After peaking at about $3,750 in mid-July, the stock began a decline and was trading below $3,200 by mid-August.
Imagine someone borrows shares of Amazon from their brokerage in the third week of July and sells them for $3,650. They’re required to return the shares to the brokerage in 60 days. If they told their broker to buy the stock in mid-August at $3,200, they would reap a profit of about $450 on the short sale and return the shares to the brokerage.
Contrary to their hopes, Amazon’s stock price starts to rebound, rising to $3,400 by the end of August. The short seller still has a few weeks before they must buy the shares in the open market and return them to the broker. To protect some of their short-sale gains, they place a buy stop order with their broker for $3,450, hoping to preserve a $200 profit.
Breakout of trading range
Investors also use buy stop orders to maximize gains from an expected surge in the stock price. In this strategy, the investor looks for patterns in recent trading prices. They’re particularly looking for points on the chart where the stock seems unable to rise beyond—what traders call a resistance level. The investor also might do some research about the company’s fundamentals—earnings and forecasts, prospects for the company’s industry—to confirm their view that the stock price is poised to rise steadily above the resistance level. Technical analysts call this a breakout above the resistance level.
Buy stop order example: Break out of trading range
Let’s use the pharmaceutical maker Pfizer Inc. as an example. During the summer of 2021 its share price rose to almost $52, a record high, but then fell back. The price has ranged between about $45 and $50 for several months.
Suppose an investor does some fundamental research about Pfizer and sees that the company has raised sales and earnings projections for the next several quarters, boosted by its world-leading position in providing Covid-19 vaccines. They also note that Pfizer has several recent or pending approvals by government regulators in the US and Europe for expanded use of the Covid vaccine and for several other medications, and settled a patent dispute with another pharmaceutical company regarding an arthritis drug.
On this basis, the investor believes Pfizer’s stock price is ready to break out of its recent trading range. They place a buy stop order at $54 a share because they want to see if the breakout is sustained after the price passes above the $52 resistance level. Once the price reaches $54, the buy stop is triggered and their broker would begin buying Pfizer shares.
What is the difference between a buy stop and a buy limit order?
The buy stop instructs a broker to begin buying once the market price rises to the designated stop price, and keep buying until the investor’s order is fulfilled.
A buy limit puts a price cap on the order: Begin buying, but don’t pay more than the limit price. The buy limit order allows an investor more control over the price paid for a security, but it may mean the investor’s order may not be fulfilled if the market price rises above the limit. This poses a risk for short sellers and investors.
For example, in the Amazon example, if the short seller placed a buy limit order for Amazon at $3,450, their broker can't buy at any price higher than $3,450. That means their short-sale profit could evaporate if Amazon’s market price continued to rise. They could even take a loss on the short sale if they buy an Amazon share for more than their original $3,650 short-sale. A buy stop order, on the other hand, could give them a better chance to preserve some short-sale profit.
In the breakout example, if an investor placed a buy limit order for Pfizer at $54 a share, their broker would not be permitted to buy above $54. Should Pfizer indeed break out of the recent trading range—let’s say the shares rise to $65 in the next month—they could miss the opportunity for that gain if they had placed a buy limit price of $54.
Downside of a buy stop order: False breakout
So what happens if the investor places their buy stop order for Pfizer at $54 a share, the market price rises past $54, their broker buys at $56, Pfizer rises more to $60 but then retreats in the next week to $53 a share? Traders call this a false breakout, meaning the rise in price beyond a resistance level wasn’t sustained.
The investor could place a stop loss order to be triggered when Pfizer’s stock price begins backsliding. For example, they might set a stop loss price of $58 a share, so that they could capture some trading gain. Or they might set the price at $55, to try to minimize their loss from the false breakout.
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