not a difficult topic but having hard time digesting this question: adams owns 100 shares of X stock, which is trading at $86, and brown is short 200 shares of X. adams wants to buy 100 more shares if the price rises to $90, and brown wants to cover his short position and take profits if price falls to $75. the orders adams and brown should enter to accomplish their objectives are: Adams Brown A. Limit buy @ 90 Limit buy @75 B. Limit buy @ 90 Stop buy @ 75 C. Stop buy @ 90 Limit buy @ 75 D. Stop buy @ 90 Stop buy @ 75 I answered B, correct answer is C. explanation: adams should enter a stop buy @ 90 which will be executed only if the stk price rises to 90. brown should enter a buy order with a limit of 75 since he wants to buy stock to close out short if he can purchase at 75 or less. from the question i was not able to ascertain that he wanted to take profits on short ONLY if price falls to 75, so figured stop buy @ 75 would trigger mkt order, being filled close to 75 and not risk market moving aways from him, > 75. also, wouldn’t a limit oder be better when going to long to mitigate risk of stock running through Stop Buy price. once the stop pt is reached, it becomes mkt order so perso may get filled at much higher px if mkt is moving fast. perhaps i am thinking too much into this or not grasping the quesiton fully. thanks, John
I think you’re just over thinking things. Focus on the long side of the question first. Adams wants to buy more shares of his stock if it reaches a higher price. A limit buy order only allows you to purchase shares of if the order is submitted below the current market price so that immediately eliminates A & B. A stop buy order is the opposite where you can set a target purchase price above the current market price. This question merely focuses on whether or not you understand limit and stop orders. You may be getting limits and stops crisscrossed.
thanks chuck. why not use a stop order to cover the short postion as well? seems like using a limit order would risk not covering the short and possibly missing the profit in this case?
It seems counter intuitive to talk about the types of transactional orders when shorting. So say I take a short position in the example above @ $86. Let’s say I’m right about the price movement and the stock price drifts down to $80. I could now use a stop buy order to lock in my profit at say $82. I could implement a limit buy order @ $75 if I believe the stock will continue to fall. You’re correct though. A limit order would not protect profit. You should use a stop order.
My first post! A good way to think about these types of problems *maybe*. When you buy a stock, you wish to buy low, so your limit price is always below the market. When you sell a stock, you wish to sell high, so your limit price is always above the market. Stop orders are exact opposite of that. When you buy, you wish to buy high, so the stop price is always above the market. When you sell, you wish to sell low, so the stop price is always below the market. So, don’t worry about whether you are long or short, decided if you are buying or selling. And if you are buying high, then its a stop, buying low is a limit, vice versa.