There are a variety of different stock orders you can use when you buy individual stocks. It pays to become very familiar with these alternatives if you are a stock trader. Even though the differences between these orders may seem slight, it can cost you a great deal of money if you slip up. It’s hard enough to find stocks to buy. Make sure that once you do so, you place your orders correctly. Here are the 5 most popular types of stock orders and how to use them.
Market orders are how the majority of stocks are bought and sold. When you place a market order, it means you want to buy or sell shares at whatever the market price is. This means you are clear on how to invest your money and you are willing to pay a little more for your shares if you have to.
If you are trading very liquid stocks, this isn’t a problem. The price you will pay will be very close to the quoted price. But if you are investing in thinly traded stocks you could get hurt by placing market orders.
That’s because thinly traded stocks typically have a large difference (or “spread”) between the buy and the sell price. And if you place a market order it means you are willing to pay whatever price the next person is willing to sell shares at. That means you could end up paying a very high price. That’s one reason people use other types of orders other than market orders (especially when dealing with stocks with low average daily volume).
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When you use a limit order to buy or sell shares you put a cap on the amount you are willing to pay (if you are buying) or a floor on the least amount you are willing to sell the shares for. If you place a limit order and the prevailing prices are better than your limits, you’ll get those better prices. Life is good. If you are worried about when to sell your shares, for example, using a limit order can take some of the pressure off.
The danger of using a limit order of course is that the price you set may never be reached. Just because you want to buy or sell at a certain price doesn’t mean you’ll be able to do so. If the market doesn’t reach your limit, your trade will not be executed. 🙁
When you place a stop order, it means that once a price is hit or breached your order becomes a market order. Let’s take a look at an example in order to understand this better.
Let’s say you like XYZ stock. It is currently trading at $35 but it’s very volatile. You place a stop order for 100 shares at $32. That means if there are any trades that are executed at $32 or less your stop order becomes activated. Once that happens, your order becomes a market order for 100 shares and you’ll get your shares at the best next price available. Theoretically, if the price jumps up to $40 per share, that’s the price you’ll pay. Confused?
If you had placed a limit order instead, the trader would have to get your 100 shares at a price of $32 or less. But using the stop order, your request becomes a market order once the price of $32 is breached. Because that order becomes at market order at that point, you might pay more or less than $32 per share. Get it? Good. Let’s continue.
Stop limit order
When you place a stop limit order you are actually placing two orders. The first is a stop order. If your stop price is breached, your limit order takes effect. It sounds complicated but it’s really not. Don’t worry. Let’s go through an example to see how this works.
You still like XYZ but rather than place a stop or limit, you place a stop $32 limit $33. This simply means that if the market price gets to $32 per share, you are willing to pay up to $33. You would use such an order with very volatile stocks. A good example is Facebook. I recommended that most people stay away from Facebook but for those who didn’t, I suggested using limit and/or stop orders for protection.
Let’s get back to XYZ. Had you placed a stop limit of $32 – the order is only activated once the price gets to $32 and the most you’ll pay is also $32. In effect, when you place a stop limit order with only one price, it’s the same as using a limit order. Make sense?
Day vs. Good till Canceled (GTC)
The last type of stock order has to do with how long your order stands and has nothing to do with price. A “Day” order is only good for the day you place the trade. At the end of the day, if the order isn’t filled, it dies. A “GTC” order is good until you cancel it and it’s exactly the opposite of market timing because you are giving the market plenty of time to either get to your trading price or not.
You can see that it makes no sense to place a “Market GTC” trade. When you place a market order it gets executed instantaneously unless your stock is so thinly traded that there are no offers to sell. This almost never happens.
“GTC” orders are very important when it comes to limit, stop and stop limit orders. Unfortunately, many people forget about this when they place their orders and it comes back to bite them. Why? Because if you neglect to specify which kind of order you want the broker will use their default. Depending on the stock broker you use the default could be exactly the opposite of what you want.
Let’s say your intentions are to place a “GTC” order because you think it might take some time before your price is met. But if you overlook specifying “GTC” when you place the order, the default might be “DAY” at the brokerage firm you use. That means your order becomes null and void after one trading day.
The worst part is that you will only discover your mistake down the road if the price hits your limit or stop and you don’t get your shares. That happens all the time and it usually steams people’s broccoli pretty good.
Stock orders are actually not as complicated as some people make them out to be. When you trade stocks, you can find yourself in high-pressure situations. Still, it makes sense to slow down a little and really think about the kind of stock order you want to use – and make sure you let your intentions be known.
Do you use plan on using stops and limits on your trade orders? Have you ever gotten hurt because you failed to do so?