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Question

Difficulty: EasyTypes of Orders and Order Execution Strategies

An investor places a sell stop order for a stock at 45whenthestockiscurrentlytradingat45 when the stock is currently trading at 50. If the market price subsequently drops to $45, which of the following best describes the execution rule for this order?

  1. The order is activated and becomes a market order to sell at the next available market price.Answer
  2. B
    The order is activated and becomes a limit order that must execute at $45 or higher.
  3. C
    The order is automatically canceled upon reaching the stop price to prevent further losses.
  4. D
    The broker-dealer is mandated to purchase the stock into its own inventory at exactly $45 acting as a dealer.

Answer

The order is activated and becomes a market order to sell at the next available market price.
A sell stop order is designed to protect a position or lock in profits by remaining inactive until the stock trades at or below the stop price. Once triggered at $45, it converts into a market order, which executes immediately at the next best available market price.

Step-by-Step Solution

1
Identify the specific order type
The order is a sell stop order set at $45.
Determining the order type establishes how the trading system handles the order when price thresholds are met.
2
Analyze the trigger condition
The stock price drops to $45, matching the stop trigger price.
A sell stop order is placed below the current market price and remains dormant until a transaction or quote occurs at or below the stop price.
3
Determine the execution status after triggering
The activated order immediately turns into a market order to sell.
Once triggered, a standard stop order becomes a market order, guaranteeing immediate execution at the next available market price.

Key Concept

Sell Stop Order Mechanics
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Topics

Types of Orders and Order Execution Strategies