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Using Stops to Prepare Yourself for Market Moves
Timing can be everything, especially when it comes to making marketing decisions. One tool that can be used to help enter or exit a market may often be overlooked (or simply forgotten). In this perspective, we will review stop orders, which can be used to enter or exit a market. It is important to understand how stops work and what can happen when they are triggered. Stop orders are typically used on futures contracts and can be used in options as well.
We will use two different fictional characters to exemplify how stop orders work: Farmer A is a hog producer who is a buyer of corn. However, he can buy only so much actual corn per week and, therefore, is exposed to market risk (higher prices) on future purchases. Farmer B is a corn producer and believes prices can move higher. He wants an order in place that allows him to be sold if prices go lower, and he wants to remain unpriced until that order is triggered.
We will start with Farmer A, and say it is June 15. Corn is priced at 3.50 on December futures. His concern is rising prices. The current price trend is down, and he believes prices can go even lower. Since a stop order is triggered when the market trades at or through the stop price, Farmer A places a buy stop order at $3.60. If prices continue to trend lower, he can buy cash corn at even lower prices. However, if prices move higher and reach $3.60, his order will be triggered, and he will be long futures. With a long futures position, he is protected against a further upward price rally.
Farmer B, on the other hand, produces corn and is concerned about lower prices. We will say it is July 4, and corn futures are at $4.00 per bushel. He may place a sell stop at $3.90 that will get triggered if prices trend down to (or through) $3.90. While the old saying is, “buy low and sell high,” it may not seem intuitive to be selling at a lower price. However, if prices drop below $3.90, it could mean the trend is turning lower and the downside objective is now in the low-$3.00 area. And $3.90 is high relative to $3.00. In this example, Farmer B is selling at what may be the high price for the year.
Stops are marketing tools that you’ll want to know how and when to use. Though you do not have to be an expert on every marketing tool available, it is helpful to know these tools exist, and to ask the right questions of those who can help you implement them. A thorough and transparent communication process between you and your adviser is an important step in successful marketing. Being prepared is key, and using stop orders can help you prepare for shifting risk when the market dictates action.
If you have questions or comments, contact Top Farmer at 1-800-TOPFARM, ext. 129.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.