Tuesday, May 19, 2009

Stop, Limit, and Market Orders

Let's look at a question on stop, limit, and market orders. Try to use process of elimination until you find a strategy that works for the following pretend customer:

Your customer purchased shares of XYZ for $40 last year. Currently, with the stock trading for $65, your customer is concerned that the stock could drop sharply from its current price, although long-term, she wants to hold this investment if possible. You would recommend that she place
A. a market order to sell
B. a buy-stop order @66
C. a sell-stop order @67
D. a sell-stop order @64

EXPLANATION: the customer does not need to buy any more stock, so you can eliminate choice B. You can eliminate choice A since the customer thinks the stock may be worth holding long-term. A sell-stop order at $67 would be executed as soon as the stock traded at $67 or lower--since the stock is already there, the order would effectively be a market order to sell that might even cost the customer more $ to place than a market order to sell. Choice C, then, can be eliminated, leaving you with the right answer, D.


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