"BUY ON STOP" ORDERS

A reader sent me an email last week asking me what a "buy on stop" order was and why I would use one. As I want to make this newsletter of maximum benefit to my readers, I am assuming many other readers have not used "buy on stop" orders before and can therefore benefit from a discussion of this trading tactic. This week I also suggested using a "sell on stop" strategy for May Department Stores.

On Thursday, April 8th, I spoke at a technical analysis society event. A subscriber introduced himself to me and suggested it would be helpful to him to discuss what shorting was in the newsletter. I was very appreciative of the suggestion, since I had not considered this as a topic before. I want to encourage other subscribers to email me topics they would like to see discussed in this section of the newsletter. I will keep a list and will try to address them all in due time. You can reach me via email by clicking here.

Virtually all brokers should allow you to place a buy on stop order. My discount broker, T.D. Waterhouse, offers both "buy on stop" and "sell on stop" choices on their pull-down order menu. These orders may be placed for a day or can be made valid until a specific calendar date. If you do choose a calendar date several weeks away, then your buy on stop order will sit in the broker's computer until the stock hits your specific target price. At that time, it will turn into a market order and will then be executed. If the stock doesn't hit the specified price level, then it will remain on the books until your predetermined calendar date or until you cancel the order.

If you do choose to put in a buy on stop order of several weeks duration, make sure you keep track of it. After all, you can get filled several weeks down the road even if market conditions have changed by then and you no longer wish to execute the trade. If your broker allows you to short online, then you can also place a sell on stop order. This will allow you to sell short a stock when it reaches a specific price. If you cannot short using your broker's online web site, then you may need to do this by telephone. Please note that you can also use a sell on stop order to set a stop loss on a long position.

For me, these kinds of orders are a very important trading tactic. When stocks trade within a set range, it implies that there is a balance of supply and demand. If a stock trades up to a previous resistance level and then fails to break out, it is telling you that there is not enough demand to push it through this obstacle.

Traders who rely on technical analysis, as well as other frustrated holders of the stock, will probably sell on the failure to break resistance. The shares will then decline and create a loss for anyone who jumped the gun.

In many cases, therefore, it pays to "buy the breakout." When a stock has exceeded a specific price level and breaks out, it communicates that buyers were willing to pay up and there was sufficient demand to move the shares higher. The breakout from resistance, particularly when it occurs on higher-than-normal volume, is one of the most reliable patterns in all of technical analysis.

This pattern worked for readers of this newsletter when we bought OmniVision (OVTI) on March 14th -- a trade that yielded us a +14% gain in about a week. The year I had more than 80% winning trades, I used "buy the breakout" as my mantra. It worked like a charm and I still associate it with the cash register jingling. When the market turns bullish, for either a short or long period, it is a strategy I will use again for my subscribers' gain.

A break of support also often means a stock will trade rapidly lower. On the other hand, a stock that holds support will frequently rally.

Another advantage of buy or sell on stop is that they keep us out of trades that could be going nowhere. With CTXS or EASI, which I've recently suggested as possible trades in this newsletter, I don't want my capital "sitting." In choppy, sideways markets where the trend is very short-lived, I want to enter positions only "when the market tells me to."

There are, of course, disadvantages to this tactic. First, you pay a higher price for the privilege of buying after the breakout occurred. Second, breakouts can and do fail. Finding a strong stock in a weak market can be a painful experience if you buy the breakout, but then general market conditions pull the stock back below the breakout level. Buying the break of support in a strong market can backfire if the overall market turns and pulls the weak stock, kicking and screaming, higher.

Despite their drawbacks, I think buy on stop and its close cousin, sell on stop, make a lot of sense. There are times that we as swing traders should step up to the plate and buy or sell short without the least hesitation. At other times, prudence is the watchword. It is at during these periods of choppy, sideways action that the buy or sell on stop strategy is often the swing trader's best friend.

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