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Question

Difficulty: EasyTypes of Orders and Order Execution Strategies

An investor who owns 100 shares of common stock currently trading at $45 per share wishes to limit potential losses if the stock's price declines sharply. Which of the following order types is most appropriate for protecting this long stock position?

  1. Sell Stop OrderAnswer
  2. B
    Sell Limit Order
  3. C
    Buy Stop Order
  4. D
    Buy Limit Order

Answer

Sell Stop Order
A Sell Stop order is placed below the current market price. When the stock price drops to or below the stop price, the order is activated (triggered) and becomes a market order to sell, thereby capping further losses for an investor holding a long position.

Step-by-Step Solution

1
Identify the investor's position and primary risk goal.
The investor holds a long stock position (owns the stock) and wants downside protection against falling prices.
Choosing the correct order type requires matching the investor's market stance (long vs. short) with the desired price trigger.
2
Evaluate the execution rules for stop versus limit orders.
A sell stop order is placed below the current market price. If the market price falls to or through the stop price, the order triggers and turns into a market order to sell immediately.
This mechanism ensures the long position is closed out if the stock price drops below the investor's chosen risk threshold.

Key Concept

Using Sell Stop Orders to Protect Long Positions
Estimated Time:45s
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Topics

Types of Orders and Order Execution Strategies