Some brokerage firms and exchanges permit the short sale of stock. If so, knowing how to use a stock sell limit order is a necessary stock trading technique. The exact opposite to a buy limit order, the sell limit order can be utilized for two primary reasons.
Using a Sell Limit Order to Enter the Market
When used in this manner, a short limit order is placed above the current price of the stock in anticipation of the stock price reversing downward once the entry price produces a fill on the short limit order. This is known as, “picking a top”. It is a risky maneuver, since to be successful it relies on price changing direction against its prevailing tendency, and trading against a trend is generally not advisable. Technical indicators such as Bollinger Bands and Fibonacci levels can be used to predict where an upward trending price stock may reverse, or correct to some degree, but using a sell limit to pick a top ignores upward momentum, and is not for the faint of heart, since stock prices often continue upward due to momentum or fundamental factors.
A less risky opportunity to use a short or sell limit order is when there is no dominant trend to the upside, and prices seem to be in a stable, sideways pattern. In this case, it is possible to predict up trending prices to reverse to the downside at a level where they have been doing so in the recent past. This level is referred to as resistance. When upward prices cannot get past a certain level and have reversed repeatedly, it is probable that they have encountered strong resistance, and a sell limit order can be placed to enter at the top of the sideways range anticipating prices retracing from a level they have repeatedly failed to penetrate.
Using a Sell Limit Order to Exit the Market
A sell limit order is used to exit the market and take a profit from an already established long position. It is placed above the current price at a pre defined profit objective, at or just below a level where resistance has prevented prices from going above.
“Limit Orders.” U.S. Securities and Exchange Commission (Home Page). N.p., n.d. Web. 1 Dec. 2010. http://www.sec.gov/answers/limit.htm.
“Stop-Limit Order.” U.S. Securities and Exchange Commission (Home Page). N.p., n.d. Web. 1 Dec. 2010. http://www.sec.gov/answers/stoplim.htm.