When you enter into a trading position in the cash market or an intraday trade or even in futures there is a margin that you need to pay. The margin is for the broker to cover the risk of your trade and even the exchange insists on minimum margin to be collectible. What if you want to pay a lower margin (in other words you want higher leverage), then what should you do. In that case you can opt for Cover Orders (CO) or for bracket orders (BO). What is a cover order in a stock? These are orders with an in-built risk mitigation mechanism. The benefits of cover orders are that they not only reduce the risk for the broker and the trader, but also enable the trader to get higher leverage. Let us understand cover order trading in greater detail and how it works in practice.
What exactly is a cover order?
In simple terms a cover order is a market order that is placed along with a Stop Loss order. You can use cover orders in case of long trades and in case of short trades too. The important part of the cover order is that it has to be placed along with the stop loss order at the time of placement of the order itself. Once the cover order is placed, the SL order cannot be cancelled as it will make the entire concept of the cover order invalid. So what exactly does this cover order do?
Since the cover order includes the stop loss order also at the time of order placement itself, it reduces the risk for the broker and for the trader. Consider the below example..
Buy order for Tata Steel placed at
Rs.720
Total quantity for the order placed
1000 shares
Stop loss placed at
Rs.710
Maximum loss if SL is triggered
Rs.10,000 {1000 x (720-710)}
Since maximum loss can be known in advance in this order the margin requirement is substantially reduced in case of cover orders. Thus as a trader you can get higher leverage from your broker as you have already pre-defined your risk. Remember one thing here. There is no guarantee that your entire order will get stopped at Rs.710. When the market is falling with thin volumes, your final price may go down to around Rs.709. But in case of most liquid stocks the difference is hardly substantial when stop losses are placed.
How to place a cover order with a fresh order?
At Motilal Oswal trading this facility is called MarginPlus wherein you place a fresh order for buy or sell on a stock and simultaneously also place a cover order where the stop loss is defined. The combination of the fresh order with cover order is called the MarginPlus facility in case of Motilal Oswal trading platform. There is an important point to remember with respect to cover orders. Firstly, all cover orders with the fresh orders will have to necessarily be market orders only. Secondly, MarginPlus is a facility to enhance your intraday volumes and get higher levels of leverage in the stock market. Thirdly, and more importantly, MarginPlus is an auto square-off product. That means this is strictly for intraday purposes only. As a result, you need to close out your position necessarily before 3.10 pm. If you do not close out your position by 3.10 pm then the system will automatically square off all open positions. Therefore fresh orders under MarginPlus are also made available only between 9.15 am and 3.10 pm. You can neither place MarginPlus orders during the pre-open period nor after 3.10 pm when the auto square-off is automatically triggered.
Improving upon cover order with a bracket order..
A bracket order is a slight improvement on the cover order. The cover order only includes the fresh order and the stop loss order. The bracket order (ProtectProfit order at Motilal) also includes the profit target set in advance. So in ProtectProfit order you have a fresh order plus a SL order as well as a profit booking order. In the above case of Tata Steel, you can also create a bracket order by setting your profit booking target at Rs.735.
What happens to the SL order if the profit target is achieved? Depending on which order is triggered first, the other order is automatically cancelled by the system. So, if your stop loss order has got triggered first then the profit booking order gets cancelled automatically. Similarly, if the profit booking target is achieved first then the stop loss order is automatically cancelled. As a trader you are free to change the stop loss levels and the profit target any number of times before 3.10 pm.
Cover orders and bracket orders are a way of mitigating the risk of your trading and also get additional leverage. You can go ahead and make the best of it!
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