Understanding Stop And Reverse Orders

A stop and reverse order, sometimes called an SAR, is a type of stop loss order that exits the current trade you're involved in and either simultaneously or immediately thereafter enters a new trade in the opposite direction. Stop and reverse orders combine elements of trade management and risk management, and they're used in place of regular stop loss orders when possible. They're not always available, but you can achieve the same end result in other ways when necessary.

The Purpose of a Stop Loss Order

First, it helps to understand stop loss orders and how they work. These orders are placed with a broker to take a certain action, either buy or sell, when a stock achieves a certain price. You can place them in advance to limit your risk if a price tanks at a time when you're unaware of the shift.

Your associated risk is correlated with the stop loss price you set. For example, if you place a stop loss order at 20 percent less than what you paid for the stock, the most you'll lose on that investment is 20 percent. 

Compare this to the other alternative. The stock tanks to 50 percent below what you paid for it without your knowledge so you have no opportunity to act and sell to mitigate your loss. 

When Are Stop And Reverse Orders Used?

Stop and reverse orders are effectively an extension of stop loss orders. They're used when a trader wants to quickly reverse his position, hence the name.

For example, if a trader is in a long trade and he wants to exit that long trade and enter a short trade at the same price, he would use a stop and reverse order.

The same task could be accomplished manually, of course, by placing an exit order then following that up by immediately placing an entry order, but stop and reverse orders are obviously more streamlined and efficient because they combine the entry and exit and all that activity into a single order.

How Do Stop And Reverse Orders Work?

Stop and reverse orders aren't a standard order type, and not all brokerages or any exchanges offer them. In fact, relatively few do. Stop and reverse orders are therefore typically implemented by the trader's trading software or order entry software, and their implementation can likewise vary significantly. The end result is the same, however—you end up with a new trade in the opposite direction. 

But not all trading software offers this stop and reverse accommodation, either. If your trading software doesn't do so, you can still manually create a stop and reverse order by doubling the number of contracts, shares, or lots in your stop loss orders. For example, if a trader is in a long trade with one contract, a stop loss order that is placed for two contracts will function exactly like a stop and reverse order.

Stop and reverse orders are not related to the Parabolic SAR indicator so a trader who is trading using the Parabolic SAR indicator might still use stop and reverse orders in his trading.

Note: Always consult with a financial professional for the most up-to-date information and trends. This article is not investment advice and it is not intended as investment advice.