Cover Orders – Features & Benefits With Example

The stock market holds both major rewards as well as significant risks for any trader or investor – therefore, in order to navigate this space, the latter must come with various strategies that balance both risk and reward. In this context, cover orders are an effective tool in the hands of traders to make sure that the maximum possible risk is limited and predefined. This allows the trader to automate their trading strategy for that particular asset and focus on other orders and strategies.

What is a cover order

A cover order is an unique order type where the trader places two different orders at the same time. One order would be either to buy or sell the stock and the other order would be a stop loss, thus allowing the trader to place the two orders simultaneously. By doing so the trader is safeguarded in limiting a potential loss that could be incurred on a position.

In other words, a cover order is made of two orders or ‘legs’ – the main leg and the secondary leg. The main leg is the primary position (i.e. buy/sell) and the secondary leg is meant to square off the position automatically to limit the losses through a stop loss order.

The cover order facility is only available for intraday orders. Upon choosing the order, you will be asked to provide the trigger price and limit price following which you can place the order.

This method is essentially used by intraday traders and hence It is vital to note that all Cover Orders must be squared-off before 3:10 p.m. every day.

Example of Cover Order

Suppose a stock is currently trading at ₹ 200. 

If your main leg is a sell order, you can set a limit order of ₹ 210 (usually a better/higher price than the market price) – the app will sell the stock when price reaches ₹ 210 or above (better). Then your secondary leg can be a stop-loss order set at ₹ 212 (the price at which the stock will be bought back to limit losses). So your potential losses will be limited to ₹ 2 while maximum gain will be ₹ 210 (in case stock price falls to ₹ 0).

If your main leg is a buy order, you can set a limit order of ₹ 190. Then your secondary leg can be a stop-loss order set at ₹ 188 (the price at which the stock will be sold off to limit losses). Your potential losses will be limited to ₹ 2 while maximum gain will be unlimited.

Different Types of Cover Orders

There are two types of cover orders in India, tailored for buying or selling stocks:

1. Long Cover Order

• Used when buying stocks (going “long”).
• Ideal when expecting the stock price to rise.
• Stop-loss is placed below the purchase price.

Example: Buy shares at ₹200 and set a stop-loss at ₹195. If the price drops to ₹195, the shares are automatically sold, limiting losses.

2. Short Cover Order:

• Used when selling stocks first (going “short”).
• Suitable when anticipating a price drop.
• Stop-loss is placed above the selling price.

Example: Sell shares at ₹200 and set a stop-loss at ₹205. If the price rises to ₹205, shares are bought back, limiting losses.

Both orders manage risk effectively, used based on whether stock prices are expected to rise or fall.

How Does a Cover Order Work?

Let us understand how a cover order works in detail:

Placing the Order

• Choose the stock you want to trade and whether to buy or sell.
• Set your entry price, either at market price or a specific limit price.
• Determine and set a stop-loss price to manage potential losses.

Order Execution

• Your main order (buy or sell) is placed in the market.
• Simultaneously, a stop-loss order is placed to protect against significant losses.

During the Trade

• If the stock price moves in your favour, you can secure a profit.
• If the price moves against you, the stop-loss limits your losses.

Closing the Trade

• You can manually close the trade at any time before the stop-loss is reached.
• If the stock hits the stop-loss level, the trade closes automatically.
• Cover orders must be closed by the end of the trading day.

Example: You buy 100 shares of ABC Company at ₹700 and set a stop-loss at ₹690. If the price rises to ₹720, you can sell for a ₹20 profit per share. If it drops to ₹690, your stop-loss triggers, limiting your loss to ₹10 per share.

Benefits of Cover Order

Using a cover order has the following benefits for a trader – 

1. The whole mechanism is completely automated, thereby allowing you to focus on the strategy aspect of the order rather than the execution of the same. The trader does not have to keep looking at the charts again and again under stress regarding whether the price has hit the required level or not. Neither does the trader have to remember the target prices of each leg, especially when the total number of orders, or assets, or strategies being handled at the same time is high.
2. The entire order can be entered in one go on the same orderpad – in other words, the buy/sell order and the stop loss order does not have to be set separately.
3. It allows the trader to know exactly what amount is the risk and what is the potential gain – in other words, the risk to reward ratio becomes quite transparent to the trader.
4. Because of the automation, the order mechanism will act much faster and will execute the order exactly at the target price – something that may not have been possible to do manually.
5. Due to the reduced risk, some stockbrokers offer a higher leverage to traders for cover orders than for simple/naked buy/sell orders.

The cover order feature allows the trader to perform a much larger number of low-risk trades without much stress or effort. It has the potential to increase the number of people engaging in stock trading manifold due to the ease of use, automation and clarity that it provides. 

For example, an office worker who remains busy throughout the entire period of trading hours can easily place a cover order and not look at the market position at all, despite all fluctuations as he/she knows that the cover order mechanism will take care of the trading the moment the target prices are hit. 

Thus, It will allow many non-traders to start engaging in stock market trading, thus increasing the liquidity in the market as well as the share prices in general.

Risks Associated With Cover Orders

Cover orders offer valuable risk management, but they come with some limitations:

• Mandatory Stop-Loss: Every cover order requires a stop-loss, which may restrict flexibility for certain trading strategies.
• Intraday Restriction: Cover orders must be squared off by the end of the trading day, making them unsuitable for longer-term trades.
• No Trailing Stops: Unlike some order types, cover orders do not allow trailing stop-losses that adjust with stock price movements.
• Slippage Risk: In volatile markets, stop-loss orders may not execute at the exact price, leading to potential losses larger than anticipated.
• Over-Trading Temptation: Lower margin requirements may encourage traders to open too many trades or positions larger than they can manage.
• Volatility Sensitivity: In highly volatile markets, cover orders may trigger too frequently, limiting potential gains.
• Limited Flexibility: Once set, the stop-loss can’t be cancelled, but it can be modified, which might limit some traders’ control over their positions.

Important features to note

1. In Angel One, you can place a cover order for only a particular set of segments (i.e. equity cash and F&O) and within a particular period of time (i.e. 9:15 am to 3:30 pm). That being said, you can modify the order or even cancel it (as long as it is an open order) .
2. Since cover orders are intraday orders, if the first leg, that is the limit order, does not get executed before market closing on the same day, then the system will automatically cancel the entire order by the time market closes for that segment.
3. Moreover, if the first leg gets executed, but the second leg, i.e. the stop loss order does not get executed, then again the system will cancel the stop loss order at the closing time and also automatically square off your position at the market price at the same time. 
4. If both the legs get executed, but the price of the asset rises to a new high later that day, you will still have booked losses because your stop loss had been triggered and thus your assets had been all sold already.

Conclusion

Therefore we can see that cover orders are an excellent tool for buying/selling any asset in the market, be it stock or commodity. If you want to avail more such exciting order facilities, try to open demat account with Angel One, India’s trusted online stockbroker.

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