How to Put Upper & Lower Limits When Selling Stocks
Knowing when to sell requires discipline.
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Upper and lower limits on sell orders can protect capital gains and prevent substantial losses in fast-moving markets. Selling stocks is an important part of portfolio rebalancing. This involves reducing positions when prices are ahead of the underlying fundamentals or when market or business conditions have deteriorated. Limit orders are the simplest way to place upper and lower limits when selling stocks.
Analyze historical price charts and underlying fundamentals to determine the appropriate upper and lower limits for selling a stock. For example, if a stock is trading at around $7.25 and you paid $6.25 for the stock, you could set your upper limit at $7 and your lower limit at $6.50 to lock in some capital gains.
Step 2Place a stop-limit sell order by setting a stop price, limit price and quantity. The stop price must be lower than the current market price of the stock and the limit price must be lower than the stop price. A stop-limit sell order becomes a limit order when the stop price is reached. However, the order will not execute below the limit price, which protects you from a significant loss if the price falls sharply. For example, a stop-limit sell order with a stop and limit price of $5 and $4.50, respectively, will fill only between these upper and lower limits.
Step 3Place a trailing stop-limit order. Depending on how your broker has implemented this order option, the stop price readjusts based on the stock price and a specified percentage or amount. For example, a trailing stop-limit sell order with a stop price percentage of 10 percent means that the stop price is $9 if the previous closing price is $10. The order becomes a market sell order only if the stock trades at $9 or lower. However, if the stock rises to $12, the new stop price is $10.80. The limit price is a specified dollar amount below the stop price. Continuing with the example, if the variance is 50 cents, the limit prices will be $8.50 and $10.30, respectively. Therefore, the order fills only within the upper and lower prices of between $9 and $8.50 and between $10.80 and $10.30, respectively.
Step 4Set upper and lower limits using options. The covered call-write strategy involves writing or selling an option contract for every 100 underlying shares at a strike price that is higher than the current market price. The lower limit is the strike price because that is what the call writer receives if the option holder exercises his rights and decides to buy the underlying shares. The upper limit is the strike price plus the premium received when writing the options. A limitation of this strategy is that you can write options on a limited number of stocks and at specified strike prices.
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Tips
- Fast-moving markets usually mean sudden and sharp changes in stock prices. Your stop-limit sell order may not be filled if the stock price drops sharply past both your stop and limit prices.
- Stock option contracts give holders the right to buy — for call options — and sell — for put options — the underlying shares at a specified strike price on or before an expiration date. The writers of these option contracts must deliver — for calls — and buy back — for puts — the shares at the respective strike prices if and when the holders exercise their rights.
Writer Bio
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.