The Art of Speculation (Part 2)

05/29/2008 12:00 am EST

Focus:

Ron Ianieri

Founder, Ion Options, LLC

Some of the other orders that are out there to help you with your trading are stop orders.  A stop order is a signal that waits for the stock to go against your position by a certain price or value.  If you are long (own) the stock and want to sell if the stock drops below a certain price, then you should use a stop.  For example, if I bought the stock at $50 and the stock has run up to $60, but now I fear that it may drop off, then I may want to place a stop at $58.  This will trigger a sell at market order if the stock trades down to $58.  We can also place a stop limit order at $58, to sell the stock at $59.  If we place the stop at $58, and then the stock gets triggered by trading below that price a sell order would be entered to sell at $59.  However, the order may not get filled, depending on the market conditions.  There is also what is called "trailing stop".  This is a stop that will trail the price of the stock by some value.  For example, I may want to trail the stock price by $2.  Each day the stock price resets in value as long as it is above my $2 stop price.  If the stock decreases in one day by more then $2, then the market or limit order would be placed.

If we combined the two types of orders we talked about today and yesterday, the limit order to sell if we hit a target and the stop (market, stop limit, trailing stop market, or trailing stop limit) we would get an OCO order.   This is an order that stands for "one cancels other".  This is important, because you do not want an order standing out there if the other side has been executed.  This works very similar to the orders above but has the cancel feature in there for us guys that forget to cancel the stop even though our target has been hit.   So, if we wanted to buy that stock and put our target price stop in $1 higher and put a stop market in $1 lower, then if the stock moved up $1, the order would sell the stock and cancel the stop.  If the stock fell $1, then it would trigger the stop and execute at the market price and cancel the order to sell $2 higher.

Other advanced system will allow you to put in advanced stops based on price triggers, trend lines, moving averages and other forms of technical analysis.  Other execution systems that are geared towards options allow you to place all of these orders on the options.  They will also allow you to set stops based on implied volatilities.  Before you enter these stops, please make sure you know exactly what will happen once that order is entered.  If not, call your broker to make sure he explains it in detail.  We recommend you use the Thinkorswim.com execution platform for several reasons, one of them being the advanced order entry capabilities it offers.

The execution system is very important.  Most systems will have your basic order entry for stocks and options.  If you are serious about trading, then you need to be able to understand and enter these advanced orders.  At minimum, you should be able to enter a trailing stop.  These types of stops may not be for everyone.  Stops are typically for those of you who enter your stock/options orders and walk away for hours, if not days, at a time.  They are also for those people that get distracted doing research and don't realize that market has made a significant move. 

More tomorrow in part 3.

By Ron Ianieri
For more information, visit: http://www.OptionsUniversity.com

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