Stocks 101: Understanding Order Types
December 6, 2011 Leave a Comment
Buying a share of stock is as simple as calling your broker and saying that you want to buy a certain amount of shares of a company at a certain time.
It is a very easy process, but as you become a more experienced investor you will realize that there are multiple ways to protect your money while it is floating in the risky seas of the stock market.
When purchasing shares of stocks, there are different types of orders you can make.
The most typical one is that of a Market Order.
This is the most commonly used method because you are basically telling your broker to buy or sell a stock at the current market price. This is the method your broker will normally use unless you tell him otherwise- you are guarenteed that your order will be executed.
The main conflict that arises when using a market order is that you are stuck paying the price when your order is executed and not at the price you expected when you placed the order. The stock market and stock prices rapidly change within seconds and it is best to find as much security as you can.
This is where the Limit Order comes in handy.
A limit order avoids the problem of buying or selling a stock at a higher or lower price than you intended on. It gives you an option to specify a price at which you will buy or sell automatically. The buy-limit order can be executed ONLY if the price of the stock you are buying is at the limit price or lower, and the sell-limit order can be executed ONLY if the sell price is at the limit price or higher.
Next is a Stop Order.
Whenever the stock price reaches the amount that you specified, it automatically becomes a market order. This is a great way to limit your losses and protect your profits. The stop price is always placed below the current market price.
For example, say you buy a stock at $20 and a week later it is selling for $40. You can protect the profit by placing a sell-stop price that sells the stock when the price falls to $30 automatically. This will save you from any further loss on your profit, but there is obviously a flaw to the stop order.
The Market fluctuates so rapidly at all times and alot of the time they are short term changes. That stock that hit $40 a share can drop to $30 a share which is the price you have the sell-stop on, but in reality, the decrease can be a temporary one and the price can go right back up on the same day. Now you just lost money because you were being to cautious. The market is a mean place sometimes.
The stop order and limit order work together in an order type called the stop-limit order.
This method gives you the most control over the price at which you will trade your shares. When your stop price is reached, the stop order becomes a limit order rather than becoming a market order.
You avoid a transaction of your stock at a price that differs from what you intend. The same problem occurs though. The market moves so rapidly and your limit order can easily be missed due to the rapid movement of the market.
Last is the Good til Canceled Order (GTC)
If you want to avoid having to change an order all of the time, this order is the way to go. These orders are placed at a limit price and last until the order is executed or you decide to cancel it. It will not be executed until the limit price is reached.
When you invest your money in the stock market, you are agreeing to make very large risks. Choose wisely the types of risks you make and try to protect your money as best you can.