"BUY ON
STOP" ORDERS
A reader sent me an email last week asking me what a
"buy on stop" order was and why I would use one. As I want to
make this newsletter of maximum benefit to my readers, I am assuming
many other readers have not used "buy on stop" orders before
and can therefore benefit from a discussion of this trading tactic. This
week I also suggested using a "sell on stop" strategy for May
Department Stores.
On Thursday, April 8th, I spoke at a technical
analysis society event. A subscriber introduced himself to me and
suggested it would be helpful to him to discuss what shorting was in the
newsletter. I was very appreciative of the suggestion, since I had not
considered this as a topic before. I want to encourage other subscribers
to email me topics they would like to see discussed in this section of
the newsletter. I will keep a list and will try to address them all in
due time. You can reach me via email by clicking
here.
Virtually all brokers should allow you to place a buy on stop order. My
discount broker, T.D. Waterhouse, offers both "buy on stop"
and "sell on stop" choices on their pull-down order menu.
These orders may be placed for a day or can be made valid until a
specific calendar date. If you do choose a calendar date several weeks
away, then your buy on stop order will sit in the broker's computer
until the stock hits your specific target price. At that time, it will
turn into a market order and will then be executed. If the stock doesn't
hit the specified price level, then it will remain on the books until
your predetermined calendar date or until you cancel the order.
If you do choose to put in a buy on stop order of
several weeks duration, make sure you keep track of it. After all, you
can get filled several weeks down the road even if market conditions
have changed by then and you no longer wish to execute the trade. If
your broker allows you to short online, then you can also place a sell
on stop order. This will allow you to sell short a stock when it reaches
a specific price. If you cannot short using your broker's online web
site, then you may need to do this by telephone. Please note that you
can also use a sell on stop order to set a stop loss on a long position.
For me, these kinds of orders are a very important
trading tactic. When stocks trade within a set range, it implies that
there is a balance of supply and demand. If a stock trades up to a
previous resistance level and then fails to break out, it is telling you
that there is not enough demand to push it through this obstacle.
Traders who rely on technical analysis, as well as
other frustrated holders of the stock, will probably sell on the failure
to break resistance. The shares will then decline and create a loss for
anyone who jumped the gun.
In many cases, therefore, it pays to "buy the
breakout." When a stock has exceeded a specific price level and
breaks out, it communicates that buyers were willing to pay up and there
was sufficient demand to move the shares higher. The breakout from
resistance, particularly when it occurs on higher-than-normal volume, is
one of the most reliable patterns in all of technical analysis.
This pattern worked for readers of this newsletter
when we bought OmniVision (OVTI) on March 14th -- a trade that yielded
us a +14% gain in about a week. The year I had more than 80% winning
trades, I used "buy the breakout" as my mantra. It worked like
a charm and I still associate it with the cash register jingling. When
the market turns bullish, for either a short or long period, it is a
strategy I will use again for my subscribers' gain.
A break of support also often means a stock will trade
rapidly lower. On the other hand, a stock that holds support will
frequently rally.
Another advantage of buy or sell on stop is that they
keep us out of trades that could be going nowhere. With CTXS or EASI,
which I've recently suggested as possible trades in this newsletter, I
don't want my capital "sitting." In choppy, sideways markets
where the trend is very short-lived, I want to enter positions only
"when the market tells me to."
There are, of course, disadvantages to this tactic.
First, you pay a higher price for the privilege of buying after the
breakout occurred. Second, breakouts can and do fail. Finding a strong
stock in a weak market can be a painful experience if you buy the
breakout, but then general market conditions pull the stock back below
the breakout level. Buying the break of support in a strong market can
backfire if the overall market turns and pulls the weak stock, kicking
and screaming, higher.
Despite their drawbacks, I think buy on stop and its
close cousin, sell on stop, make a lot of sense. There are times that we
as swing traders should step up to the plate and buy or sell short
without the least hesitation. At other times, prudence is the watchword.
It is at during these periods of choppy, sideways action that the buy or
sell on stop strategy is often the swing trader's best friend.
