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A buy stop order tells a broker to buy a security when its price reaches a certain level. When the price reaches that point, the buy stop changes into a limit or a market order that can be filled at the following price.
Stocks, futures, forex, or a number of other trading products may be subject to this kind of stop order. With the underlying assumption that a share price that rises to a given height will continue to rise, the purchase stop order can be used for a variety of purposes.
The most common application of a purchase stop order is as a safeguard against the potentially infinite losses of an unprotected short position. An investor will start a short position if they believe the price of the security will fall. In that case, the investor can purchase the less expensive shares and benefit from the price differential between the short sale and the long position purchase. By setting a purchase stop order to cover the short position at a price that limits losses, the investor can guard against an increase in share price. The buy stop is frequently referred to as a stop loss order when used to close out a short position.
