Buy Stops Above and Example

What Are Buy Stops Above?

Buy stops above refers to a belief that an asset's price will accelerate upward once it breaks through a level of resistance or key price level. The acceleration comes from a concentration of buy stop orders. These orders could be placed by people looking to enter long positions if the price breaks above the key level. Buy stop orders are also placed by people in short positions looking to exit if the price moves above the resistance level. In either case, there are likely buy stop orders above the resistance level.

How to Use Buy Stops Above

Buy stops above is based on the technical analysis concepts of support and resistance.

Resistance and support are areas where the price has struggled to move higher or lower, respectively. Both areas are the result of a concentration of limit orders at those prices. At resistance, investors have placed a disproportionate number of sell limit orders. At support, a large number of buy orders create a floor for the price.

The buy stops above theory comes into play as the share price approaches resistance. As the price approaches that level, those concentrated sell limit orders will be executed. This tends to send the price back below resistance. If the price can survive that wave of selling, it will continue upward above resistance. If the price moves above the resistance line, the sell limit orders will likely be exhausted and now mostly buy stop orders will remain.

A buy stop order is used to buy when the price moves above a specific price. Short traders use them to exit their short positions. Buyers use them to enter as the price surpasses key levels. Since the price has surpassed the resistance level, there is likely to be lots of buy stop orders, from both buyers and short-sellers exiting their positions, to help fuel the price higher.

Price Movement Following a Resistance Breakout

Once the price has moved above resistance, it is called a breakout. In a self-fulfilling prophecy, many traders buy breakouts above resistance, because they believe other people will as well. Hence the belief there are lots of buy stop orders above resistance.

In reality, this isn't always the case. A price move above resistance can also result in a false breakout. That is when the price moves above resistance, but there is not enough buying interest to keep the price up there. Instead, more sellers come back in, pushing the price back below resistance.

Example of How to Use Buy Stops Above

The buy stops above theory is most likely to be accurate when the price of the asset is already in an uptrend. The uptrend means buyers are stronger than sellers already. If the price can break through resistance, this may result in even more buyers in the short-term, helping to fuel the price higher.

Tesla Inc. (TSLA) was already in an uptrend when it broke above resistance near $1,000. This round dollar number is also likely to draw in additional interest.

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After moving above the resistance level, the buy stops kicked in and the price accelerated to the upside. The buy would also be fueled by buy limit and buy market orders.

If there is a collection of buy stop orders above a resistance level, this will typically be confirmed by an increase in volume. Each of the breakouts shown on the chart was on increased volume relative to recent volume.

The Difference Between a Buy Stop and a Sell Stop

A buy stop order buys when the price moves above a specified point. A sell stop order sells or shorts when the price drops below a specified level. Sell stops below refers to a potential collection of sell stop orders below a support level.

The Limitations of Using Buy Stops Above

Traders don't actually know if there are lots of buy stops above a resistance level. They can only guess or estimate that there is.

Buy stops above is related to technical analysis and resistance, but not all price movement is technical in nature. Investors may buy an asset not because it broke above resistance but because the company or industry has positive news or sentiment surrounding it.

As discussed, there are not always enough buy stop orders above resistance levels to keep pushing the price higher. The price may fall, in which case technical traders use a stop loss to help limit their risk of loss.