Understanding the Power of Cover Orders in Stock Trading

Everyone who has tried their luck in the share market would agree that it offers a combination of risks and rewards. While avoiding risk completely is not really an option, as a trader, you may have come across various tools and strategies that can act as a risk mitigation mechanism.
 

One such tool is what we call a cover order. When used correctly, this is a remarkable tool that can ensure the risk is restricted as much as possible. We explain the meaning of cover order and help you understand how, as a trader, you can automate your strategies for a particular asset while also focusing on other orders and strategies.

• With a cover order, traders can set a stop-loss to automatically limit losses.

• This ensures a predefined maximum risk for each trade.

• Investors get greater leverage on their trading positions.

• It encourages a structured trading approach and reduces the need for constant price monitoring.

When an investor takes a position in the stock market, they need to deposit a margin with their broker to cover the risks associated with the trade. The stock exchange also sets a minimum margin requirement for such positions. As an investor, if you want to reduce the margin payment and increase leverage, you can opt for a cover order (CO). This specialised form of trading pairs a market or limit order with a stop-loss order to manage risk while enhancing potential returns.
 

Cover order = Initial order (buy or sell) + Stop-loss order (sell or buy)
 

Also said to be an in-built risk minimisation mechanism, a cover order is a market order paired with a stop-loss order to manage risk. Whether going long or short, a cover order allows you to place both orders simultaneously. The key aspect is that the stop-loss must be included right when the cover order is placed, protecting from excessive losses upfront.
 

Cover orders are designed to minimise risk for both the broker and the trader while enabling traders to make better use of leverage. By combining a market order with a stop-loss, traders can manage potential losses more effectively while maximising their exposure to market opportunities.

Let's take a look at this example to understand how cover order works. Suppose you buy a stock at Rs. 100 and set a stop-loss at Rs. 90. The shares will automatically be sold if the price drops to Rs. 90. This feature in cover order trading helps limit the investor's risk. Keep in mind:

• While you can adjust the stop-loss price, you can't cancel it..

• Cover orders are not allowed on the Bombay Stock
  Exchange and across F&O segments.

Depending on your choice to either purchase or sell an asset, a cover order can be divided into two types:

1. Long cover order
   A long cover order is placed when a trader wants to buy stocks during the trading session, usually following a bullish trend. It includes a stop-loss order set at a price lower than the purchase price to protect against potential losses. This setup helps traders manage risk while capitalising on upward market movements.
2. Short cover order
   When traders wish to sell stocks, they put a short cover order, with the stop-loss set higher than the selling price. This is the opposite of a long-cover order, where the main aim is to make profits while selling stocks.

Now, let us take a look at the benefits that you can expect with a cover order:

1. You can enjoy a higher leverage
   As a cover order works on the mechanism of a stop-loss order, as an investor, you get to enjoy higher leverage on the trading position.
2. The associated risk is lowered
   When placing a cover order, the trading risk is significantly reduced due to the stop-loss feature. This ensures that the maximum possible loss is predetermined, allowing traders to manage their risk effectively. As the tool helps minimise potential losses automatically, you are in a position to confidently place buy or sell orders.
3. Makes trading systematic
   Cover order provides a stop-loss as a safety net against losses. Therefore, it allows you to trade more systematically with a stop-loss for every trade.