Stop Loss Orders aim to protect the free fall of a declining security – thus limiting the loss or protecting the profit. On a rising trend, it is better to have a trailing stop loss order. More importantly, stop loss orders should be at a certain distance from the market price level in order to avoid execution by a choppy market.
In contrast, Stop Buy Orders are applicable in the context of shorting stocks. You instruct your broker to buy a stock after it reaches certain price level. Again if the stock is moving down, it is appropriate to have trailing stop buy orders.
The following example will clarify the above point:
I purchase a stock at $10 and in a month’s time it rises to $15. I want to lock my profit now. I will ask my broker to place a stop loss order at $13 (some distance below the current price). Suppose the stock next moves to $20. I will ask my broker to shift the stop loss order to $17. In other words, I have put a trailing stop loss order at some distance (typically this distance can be 10-15% of the change in price level).
Suppose I shorted a stock at $20 and hope that it will decrease in price. The stock slides to $15. I am nervous that the stock may not rise back to $20 or go beyond it. I would ask my broker to put a stop buy order at $17 just above $15. If the stock declines further to $13, I will trail the stop buy order to $15. Just to refresh the memory of readers, stop buy order is applicable when we short stocks. Shorting is a process whereby you would borrow stocks from your broker and sell them in market with the hope to buy back those stocks at a lower price level. The risk is an unexpected increase in the price of stock. Regardless of the price of shorted stocks, the investor is bound to return the borrowed stocks to the broker. If the stock price declines, the short will gain profit; conversely if the price goes up, the short will lose money.
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