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Difficulty: EasyTypes of Orders and Order Execution Strategies

An investor who currently holds a long stock position wants to protect against potential loss if the stock's price drops. The investor places an order to sell the shares if the market price falls to $40 per share, specifying that once the price is reached, the order should execute immediately at the best available price. Which type of order did the investor place?

  1. A sell stop orderAnswer
  2. B
    A sell limit order
  3. C
    A buy limit order
  4. D
    A buy stop order

Answer

A sell stop order is placed below the current market price to limit potential downside losses on a long position by converting to a market order once triggered.
A sell stop order is entered below the current market price to protect a long stock position against declining market prices. Once the market price reaches or drops below the specified stop price, the order activates and becomes a market order to sell immediately at the next available market price.

Step-by-Step Solution

1
Analyze the investor's objective and condition for execution.
The investor owns shares (long position) and seeks protection against a falling stock price.
Downside protection for long positions requires an order placed below the prevailing market price.
2
Identify the order type that converts into an immediate market order upon reaching the trigger price.
The order transforms into a market order to sell at the best available price as soon as the trigger price is hit.
This behavior defines a sell stop order.

Key Concept

Sell Stop Order Mechanics
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Topics

Types of Orders and Order Execution Strategies