Knowledge Base

Bracket Orders: What are they and what are their benefits? Part 2

in Basics of trading
Tags: bracket orderstop loss order

A Bracket Order is a collection of orders that allows an investor to trade actively in financial markets, without requiring continuous attention. These orders mandate the brokerage to automatically sell/buy an asset depending on certain conditions set by the investor. These conditions usually relate to stock price levels. This protects the investor from excessive losses while safeguarding his profits.

A bracket order primarily consists of three parts – the principal, the take-profit and the stop-loss orders.

The three orders that constitute a bracket order are as follows:

  • Principal order: This is a limit order to buy or short sell a specific quantity of an asset. Short-selling is when you borrow and sell an asset to buy it later at a lower price. A limit order helps you prescribe the price at which you want to buy or sell a specific asset, mostly shares. A limit buy order allows you to buy an asset at or below a specific price. So, the order gets triggered when the price falls to the prescribed levels. Similarly, a limit sell order allows you to sell an asset at or above a specific price level. It gets triggered when the price rises to the said levels. If the market price does not fall or rise to reach the order’s price levels within the period specified by the investor, the order expires. A bracket order’s key component is this limit order – also called the principal order.
  • Take-profit order: This order, as the name specifies, helps you book profits and exit the position taken in the principal order. As per this, you place another limit order, thus defining the price target. So, you bought the asset in the first leg, here, you will place a sell order at a higher price. If you shorted the asset in the first leg, here, you will place a buy order at a lower price and make a profit.
  • Stop-loss order: The previous order – which helps you book profits – will only be executed if the asset’s price moves in the favorable direction. The stop-loss order helps act as a safety net.
    In the stop-loss order, you specify a price at which your position must be exited if the price moves in the contrary direction, so as to limit you loss. In case of an original buy position, here, you will specify a lower target price to sell the asset at. In case of an original short position, you will place a buy order with a higher target price.A useful variant of the conventional stop loss order is a trailing stop loss order. This allows the stop loss price to constantly move up as the market price of the asset increases. This reduces your loss potential. In case of a short sale, it is the other way around.

Benefits of bracket orders:

The principal benefit of a bracket order is that it allows an investor to trade actively without requiring constant monitoring. It thus saves a significant share of time. Stop-loss and take-profit orders can be placed together, in advance. Since execution is electronic, there is no prospect of a delay in execution and missing a price level. Lastly, in case of a change in investor strategy or outlook, stop-loss and take-profit orders can always be revisited.

How bracket buy orders work:

Assume that a stock is trading at Rs 50. An investor expects it to rise to Rs 65, but fears that it might fall below Rs 45 too. He will buy it at Rs 50. Simultaneously, he will issue two sell orders – one at Rs 65 (take-profit order) and another at Rs 45 (stop-loss order). Now, if the stock appreciates to Rs 65, it will automatically be sold at this price and the other order gets cancelled. Similarly, if it falls to Rs 45, the take-profit order will be cancelled and the stock will be sold at the next best price available. The advantage of this is that if the stock were to fall below Rs 45, the investor will be spared the excess loss. However, if it appreciates above Rs 65, the investor will miss on the extra profit.

How bracket sell orders work:

Now, assume that a stock is at Rs 80 and is expected to fall to Rs 60. An investor decides to benefit from this by shorting it. He borrows the stock at the current price and sells it. He will buy it back when the price falls and return it to the lender. If the stock appreciates instead of falling, he will incur a loss. To limit his loss and secure his profit, he will book a bracket order. He sells the stock at Rs 80. Then, he issues a buy order at Rs 60 to secure his profit (the take-profit order) and another at Rs 85 to limit his loss (stop loss).