Question

Which of the following would be a common use of a stop order?

1) To protect the profit on a long position.
2) To prevent loss in a short position.
3) To buy at a specific price guaranteed by a specialist.
4) To lock in a price with the specialist.

Answer 1

The correct option is 1 & 2). A stop order is most commonly used to protect profits on a long position or limit losses on a short position. Investors can purchase stocks through brokers or online platforms, and diversifying one's portfolio is key to managing investment risk.

Step-by-step explanation:

A stop order can be used for different purposes when trading stocks. The scenarios mentioned all relate to managing risk and locking in profits or limiting losses. Specifically, a stop order can be set to accomplish the following:

1. Protect the profit on a long position. If you have purchased shares at a lower price and the price has risen, a stop order can be set above the purchase price to ensure that some profits are retained in case the stock price starts to fall.
2. Prevent loss in a short position. If you have sold shares you do not own (short-selling), expecting the stock price to fall, a stop order can be used to buy the shares back if the price rises to a certain level, thereby limiting your losses.
3. To buy at a specific price is typically done using a limit order, not a stop order. A limit order ensures that you buy or sell at a certain price or better, but doesn't guarantee the execution if the stock never reaches that price.
4. Locking in a price with a specialist is not a common use of a stop order. Dealers, such as specialists, may facilitate trades but a stop order is not about locking in a price with them.

In the context of the options given, the most common uses for a stop order would indeed be to protect the profit in a long position (option 1) and to prevent loss in a short position (option 2).

Investing in Stocks

To purchase stocks, one could go to stock brokers or use online trading platforms. These entities act as intermediaries between buyers and sellers in the stock market.

Portfolio Diversification

Diversifying your portfolio is crucial to reduce risk. This means investing in various assets or securities across different sectors or geographies. Portfolio diversification can help mitigate the impact of poor performance from a single investment.