Always Have a Contingency Plan
Many stock brokers offer special orders called Contingent Orders which include One Cancels Other (OCO) orders and Trailing Stops (TS). Using these orders can provide investors with powerful tools to buy positions close to their lows or sell positions close to their highs.
The best way to discover how these two orders work is to take a look at an example.
A Contingent a Day Keeps Apple in Play
When Apple (AAPL) started rocketing skyward in March following several hardware announcements and excitement over their streaming-services announcement, we wanted to protect our gains, however we didn’t want to jump the gun by selling shares too early, missing out if Apple reached higher highs. This kind of scenario is exactly when Contingent Orders can be incredibly powerful.
To accomplish our goal, we could use two different kinds of Contingent Orders: a One Cancels Other (OCO) order or a Trailing Stop (TS).
Although not offered on Robinhood, many brokerages like Charles Schwab and others allow investors and traders to place contingent orders.
One Cancels Other (OCO) Orders
When a trader creates a OCO order, we place two different orders at the same time, however the broker will automatically cancel the open order if either of the two fill.
In this case, our two orders would be (1) a stop-loss limit order to sell Apple at a minimum price if it drops below our set price and (2) a regular limit order to sell Apple if it reaches our target price. The OCO element to this order means the broker will automatically cancel the other order if either move happens.
Using an OCO protects against a stock’s volatility where a big enough range could result in our higher limit-order being filled followed by a significant price reversal also filling the other order if Apple’s price dropped which would result in twice as much stock being sold as we wanted.
The Trailing Stop (TS) Order
We opted to use a Trailing Stop (TS) with Apple. A TS order allows the trader or investor to automatically buy or sell a stock if it suddenly changes direction and reverses by a set amount. The investor sets how far above or below the current price to execute the order by a set amount either by price or percentage.
In our example, we observed that Apple had never retreated more than 2% before heading higher in its current run, so we set a trailing stop at 2%.
As Apple heads higher, the brokerage automatically raises our sell order to match 2% less than the last highest price. If Apple reverses direction, our sell price does not go down meaning that Apple will automatically sell if it retreats 2% from its last upward high point.
Of course, using a trailing stop in this case this means we will lose 2% of our profits from Apple’s last highest price point, but we will protect the profits we have up until our 2% stop.
Trailing Stop orders also work for buy orders. An investor who wants to buy a stock dropping in price sets a certain amount the stock can move up before the order fills.
We placed our trailing stop to follow 2% lower than Apple’s trading price when it was trading at $187.68.
When Apple’s upward momentum increased, we decreased our trailing stop to 1% below the current level to capture additional gains.
Apple hit a high of $197.66, reversed and dropped to our stop price of $195.68 (1% less than $197.66 i.e. $197.66 * 99% = $195.68) before our order filled at $195.20 – a 4% improvement over a standard limit sell order at $187.68 where we opened the trade.
Many investors and traders will never need or use contingent orders, however contingent orders can certainly be powerful tools if investors want to attempt to capture as much as gain as possible or try to buy a stock near its lowest levels.