TOP FARMER WEEKLY PERSPECTIVE 6/3/2022 BY BRYAN DOHERTY
Using Stop Orders
Using stop orders when trading futures or options is a means to manage risk of an existing position, or a method to enter a new position. Stop orders are orders placed at an exchange through a broker. Buy stop orders are placed above the current market price (last trade or settlement price) and sell stop orders placed below the current market price. Stops are usually placed as good until canceled (GTC), though that is not required. They could be placed for the remainder of the session or, in some cases, for a certain length of time during the session. Stop orders are triggered when the market touches or goes through the stop price. Once triggered, stops are filled at the best price possible offered at the time the order is triggered.
When would a farmer use a stop order? This Perspective will provide several brief examples of when a commodity producer or buyer may use a stop order. A more thorough explanation and implementation practice should be discussed with your advisor. Let’s start with a sell stop. If December corn futures are trading at $7.25 and you believe prices will go higher, yet you want the assurance to be a seller if prices drop, you could put a stop order under the market at, say, $7.15. Until futures drop and touch or go through $7.15, you are not a seller. The idea is to keep the upside for price appreciation in place until the stop is triggered. If futures were to move higher, you could then change the stop order from $7.15 to a higher level. This is often referred to as a trailing stop. There are a couple of downsides to stops. If prices trigger the stop, you are sold at a lower level than at the time the stop was placed. Additionally, when a stop is triggered, it becomes a market order by definition, and the order fills at the best price possible, which could be lower than the stop price. In a fast-moving market, or in an environment when the market bias quickly changes (think USDA reports), the stop could be triggered and filled at the stop price just before the market changes direction and moves to a more favorable price. If futures were locked limit, the order may not be filled at all.
Buy stops are the opposite of sell stops. They are placed above the market and also triggered if prices touch or go through the stop price. Those wanting to protect the upward price of a commodity, such as feed buyers, may consider buy stops. Or, producers who sell could use a buy stop to re-enter an ownership position. If you sold cash corn (say, to generate cash flow) and want to potentially retain a long position on paper, this is a method to retain ownership, though only if the buy stop is triggered. As with sell stops, the risks are similar. If triggered, you are buying at a price higher than when you placed the stop, and the exact price is not known until the order is filled.
Traders will often use stops to manage risk on positions. For instance, if someone is short (sold futures), they could use a buy stop to manage upside risk. While a stop doesn’t guarantee your risk, it does at least provide a trigger point that, in most cases and within reason, will give you some idea of your risk. If a trader is long futures, a sell stop can be used to manage risk, should prices drop. Some traders may use a buy or sell stop to enter a market, depending on their directional bias.
As with any marketing tool, have a thorough understanding of the risks and how to implement the strategy before entering any position. Stops are just one more tool in your toolbox of marketing alternatives. Knowing when to use the right tool for the job can provide peace of mind, especially when trying to reduce your exposure to volatile markets.
If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.
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.
Author
Bryan Doherty