1-19-2012
During a recent program, I discussed a market rise that may have been created when “buy stops” were reached by a price rally. A buy stop is an order that one places with their broker or execution program that buys at market, once price trades at a selected price level. For example, the old high in October 2011 in the Nasdaq100 futures NQH12 was 2396.50. A trader who was betting that the Eurozone would cause prices to fall in the equity markets may have sold the Nasdaq futures short making a bet on such a call. However, this trader may have placed an order to get them out of the short position and take the loss, if prices set a new high. They may have placed a buy stop order at 2398.00 for example. If the March futures traded at that price or above, their order would buy at market at whatever the best asking price may be at that particular time. As you can tell, the best asking price may be well above 2398.00 by the time the order reaches the market. The price may “slip” away from the trader and the order may actually be filled at 2399.00 or even higher. This is what is meant by the term price slippage. The chart below illustrates the recent rally in the daily chart.
By the way, prices have had a very nice price run for the past few weeks. A correction in this trend should come at any time.
Buy stops can be a factor when trading intraday charts as well. Look at the 60 minute chart below.
The chart above is the recent price action. Now imagine traders who may have sold the Nasdaq futures short in the area represented by the rectangle. Now where do you imagine they would place a buy stop order to close any short position? Might they be thinking, “if the market sets a new high for the day, I will close out my short position and take the loss?”
Now here is what happens when a series of buy stops are “hit”. At a variety of prices within close proximity, the buy stops are hit and “go to market”. As you can imagine, an order to buy at whatever the best offer may be at the time can cause a swift rise in price. Traders around the globe are almost yelling at their monitors to “get them out” to stop the loss of dollars in their accounts. They made the wrong bet and now they are running for cover. This is what causes the large range in the bar chart.
What happens afterward when the eager buying is over? Once the buy stops have been executed, the market orders are gone. Many times, prices have reached a price level where there are not eager buyers, but thankful sellers. The traders who were long begin saying “Finally! It’s time to take my profits.” These traders then step over themselves selling the market quickly so their profits do not evaporate too quickly. When this happens, you get the price reversal that you see in the above chart.
This dance between the buyers and sellers, who are taking their losses or taking their profits, happens everyday. The idea is to try and make sure it is you who are taking profits more often then the guy who is taking the loss.
