user: Explain gaps in stock charts. What happens with open limit orders from the day before, when a gap occurs?

assistant: Gaps in stock charts occur when there is a significant difference in the price of a stock between the market's close on one day and its opening on the next day. Gaps can result from various factors, such as earnings reports, changes in industry or economic conditions, news affecting the company, or significant changes in market sentiment. Gaps can occur in both upward (bullish) and downward (bearish) directions.

Regarding open limit orders from the previous day when a gap occurs:

1. Buy limit orders: If you have a buy limit order set at a price below the opening price after a gap up, your order will not be executed immediately since the stock is now trading at a higher price than your specified limit. The order will remain open, waiting for the stock price to come down to your specified limit, which may or may not happen. If the stock price does reach your limit price, the order will be executed.

1. Sell limit orders: If you have a sell limit order set at a price above the opening price after a gap down, your order will not be executed immediately since the stock is now trading at a lower price than your specified limit. Similar to the buy limit order, your sell limit order will remain open, waiting for the stock price to rise to your specified limit, which may or may not happen. If the stock price does reach your limit price, the order will be executed.

1. Buy stop orders: If you have a buy stop order set at a price above the opening price after a gap up, your order will be triggered and executed at or near the opening price, potentially resulting in a purchase at a higher price than you initially intended.

1. Sell stop orders: If you have a sell stop order set at a price below the opening price after a gap down, your order will be triggered and executed at or near the opening price, potentially resulting in a sale at a lower price than you initially intended.

In summary, gaps in stock charts can affect open limit and stop orders from the previous day, leading to situations where the orders remain open or are executed at less favorable prices than initially intended.

user: Can you give an example of what occurs when you have a sell stop order when a gap down occurs? Please provide an explanation of the potential losses involved.

assistant: Sure, here's an example of what could happen with a sell stop order when a gap down occurs:

Suppose you own 100 shares of XYZ stock, which is currently trading at $50 per share. You want to limit your potential losses in case the stock price drops, so you place a sell stop order at $45 per share. This means that if the stock price falls to $45 or below, your order will be triggered and your shares will be sold automatically.

Now, suppose that after the market closes, XYZ announces disappointing earnings results. When the market opens the next day, there is a large gap down in the stock price, and it opens at $40 per share. Since the stock price has fallen below your sell stop price of $45 per share, your sell stop order is triggered, and your shares are sold automatically.

In this scenario, you would have sold your 100 shares at $45 per share, which is the price you specified in your sell stop order. This means you would have realized a loss of $5 per share, or $500 total, compared to the previous day's closing price of $50 per share. This is because the gap down caused the stock price to drop below your stop price, resulting in your shares being sold at a lower price than you had hoped.

However, it's important to note that a sell stop order is designed to limit potential losses, and it may not always result in the best possible outcome. In some cases, the stock price could gap down even further, causing you to realize even greater losses than you would have without the sell stop order in place. It's also possible that the stock price could recover after the gap down, and you would have missed out on potential gains by selling your shares too early.

Overall, it's important to carefully consider the potential risks and benefits of using sell stop orders, and to make sure you fully understand how they work before placing any orders.