What is a Cover Order?
When you participate in intraday trading in the cash market or futures market, a specific amount of margin is required. This margin covers the risk of your trade. But, what if you get an option to pay a lower margin to trade and get more leverage at the same time?
In that case, you can select Cover Orders (CO). These orders are in-built risk-management mechanisms to minimise risk in intraday trade. Cover orders minimise your trade risk and benefit you with an additional margin.
What is Cover Order?
Cover order is a special order in intraday trading, giving a trader the advantage of extra leverage margins and limited risk. It is a combination of a market or limit order and a stop loss order. These orders can be placed for both long and short trades.
A significant number of cover and stop loss orders should be placed in order. After placing the Cover Order, you cannot cancel the stop loss order. The stop loss price has to be set at the time of order placement, narrowing the risk for both the trader and the broker.
How Does Cover Order Work?
Cover order is a combination of two different orders. Here, a trader places buy or sell orders with a mandatory stop loss order at a lower price for buying and a higher price for selling.
- The buy/sell Cover Order can be a market or limit order. A market order is where a trader enters a trade at the best possible market price to buy/sell a stock.
A limit order is where a trader wants to enter a trade at a desired price of the stock. In other words, the trade will only get executed at a predetermined price level or lower and can be sold at a desired price level or higher.
- There is a stop-loss order for every buy or sell Cover Order. This stop-loss order is considered to be a pending order in the order book. The order gets triggered if the stock price touches the stop loss.
- The stock exchange daily defines the trigger price range, and the trader must place the stop-loss order within a specific range. For example, ICICI bank trades at ₹800; the mentioned range is 10%. In this scenario, the client can put a stop loss order within the price range ₹720 to ₹880. Once the trigger price of the stop-loss order gets activated, the order is executed at the best available price.
- A trader cannot cancel a Cover Order after execution. The trader can only exit the executed buy/sell order. Stop-loss orders can be modified within the price range mentioned.
Understanding Cover Orders through Scenarios
- Scenario 1.
A market order is placed for buying stocks and stop-loss is triggered.
A trader places a Cover Order at 12:00 pm to buy 100 shares of TATA MOTORS. The Market Order mechanism executes the order at ₹400/share; the stop-loss is set at ₹370/share. At 1:30 pm, the stock’s price falls to ₹390.
It goes further down to ₹370 at 2:00 pm and the stop loss price gets triggered; those 100 shares of TATA MOTORS get sold automatically. Here, the trader loses ₹(400 – 370)*100 = ₹3000.
- Scenario 2.
A market order is placed to sell a stock and stop loss modification is triggered.
A trader places a Cover order at 1:00 pm to sell 100 shares of ITC limited using the Market Order mechanism. Best available price in the market was ₹300/share. The trader sets the stop loss at ₹320/share.
At 1:15 pm, the share price stands at ₹308, and the trader decides to modify the stop loss level at ₹310/share. At 1:20 pm, the price hits ₹310, and the stop loss gets triggered. The position gets squared off. This reduces the loss to ₹10/share.
What Are the Types of Cover Orders?
Here are the two types of Cover Orders that traders can place:
- Short Cover Order: When a trader decides to sell shares by placing a cover order, he/she is referred to as a short seller. Traders go short on a trade if they wish to sell at a higher price and purchase at a lower price. In a short Cover Order, the stop loss price is higher than the selling price.
- Long Cover Order: When a trader purchases shares of a company by placing a cover order, it means that he/she placed a long Cover Order. Here, the aim of the trader is to buy at a lower price and later sell at a higher price. In Long Cover Order, the stop loss price is below the purchasing price.
Advantages of Cover Order
Here are some benefits of placing Cover Orders:
- High Leverage traders prefer placing Cover Order while holding their position in the market as it includes the stop loss order. This notably reduces the risk related to intraday trading. It simultaneously decreases the margin requirement for the trade.
- Cover Orders reduce the risk of a trading position greatly, especially for traders who have a low-risk appetite. The stop loss order makes the trade risk defined. A trader knows about the risk beforehand while placing a cover order and can act according to his/her risk appetite. Moreover, a trader doesn’t need to monitor prices continuously.
Disadvantages of Cover Order
Here are some risks associated with placing Cover Orders:
- Traders can’t cancel stop loss orders. They can only modify the stop loss value.
- Traders cannot exit cover orders directly. They need to close the buy/sell order first to exit.
- A trading position automatically gets squared off when stop loss remains untriggered. It results in lower gains on capital.
These are the few drawbacks a trader can face when placing a Cover Order. Intraday traders frequently use Cover Orders to guard against the risk of price fluctuation in stocks.
Cover orders limit the risk of trading positions. It provides additional leverage for the trade, especially for day trades as the price fluctuations are higher. Both buy and sell cover orders are time-saving.
Stop loss orders cancel automatically during the closing time of the market. Cover Orders don’t work on a manual basis; hence, the position gets squared off automatically. Before placing a cover order, you must learn about how the order system works.
Frequently Asked Questions
How to place a cover Order?
These orders can be placed while buying or selling stock from the broker’s trading terminal. Choose CO for Cover order at the time of the trade, select the limit price or market price and a stop loss trigger price.
What happens when the stop loss price is triggered?
The position gets squared off automatically on hitting the stop loss price. You can’t cancel the stop loss order; you can only modify it.
Do cover orders help in day trading?
It saves traders a lot of time and is very helpful in intraday trading. A single order covering both long/short with a stop loss helps in saving time. A cover order gets squared off automatically once the stop loss is triggered.
Are cover orders allowed in options trading?
No, cover orders aren’t allowed on the Bombay Stock Exchange. Also, when placing a buy cover order, make sure that the limit price is greater than your stop loss trigger price. On the other hand, if you place a sell cover order, the limit price should be lower than the stop loss trigger price.