Inside Online Investing: A Stockbroker Tells You What You Really Need to Know
From Chapter 9 - Enter Orders the Right Way
Order Types
Once you've told your brokerage what you are buying or selling, you need to tell them the price you want to pay or receive. You will typically see four choices when it comes to setting the order type or price. Unlike most guides, I will describe each type of order in detail to let you know the relative benefits or drawbacks of each order type. It is vital that you understand each order type precisely and accurately! Ignorance is expensive.
Market order
A market order means to buy or sell at whatever the next best available price is at the time the order is executed. This is the most common order type. All you have to do is select "market" or "market order" from the list of transactions. You do not have to fill in the price, because you say that you're willing to take whatever the prevailing price is at the time. Market orders are filled immediately, so you don't have to specify a time limit.There are a few things you have to know about placing market orders:
- Market orders have priority over any other type of order. That means they will be fulfilled first. Market orders are guaranteed execution, because there is always someone willing to take the other side of your order (if you're selling you'll always find a buyer somewhere).
- They will usually be fulfilled almost immediately, often in just seconds.
- There is NO GUARANTEE of the price you will get when your order is executed. A market order says you are willing to take the whatever the market price is when your order gets to the exchange or market maker. The market price at that time may or may not be the same price as previously quoted to you, even if you got that quote only seconds earlier. Stock prices fluctuate constantly, and they can move up or down in an eye blink. Most likely you'll get your order fulfilled at the currently quote, but not necessarily so. Sometimes the price will move in your favor. Sometimes it will not.
Not everybody places orders when the market is open. Many people enter their orders in the evening, when they have time to review their portfolios and get the day's closing prices. But if someone enters a market order while the market is closed, and that order is to be executed as soon as the market opens, will they be locked in at the closing price? The answer is ABSOLUTELY NOT. One day's opening price is not necessarily going to be the same as the previous day's closing price. I’ve had to tell that to a few people who were quite astonished to find out that they were not locked in at the previous day's close.
One of my clients listened to the evening financial news, and heard about a computer stock that announced earnings well exceeding Wall Street expectations. As soon as he heard the news, he placed a market order to buy when the market opened the next day. The stock jumped as soon as the market opened and he paid about $8 a share more than he expected. He's not the only one listening to the financial news, and not the only one flooding the market with buy orders. When he said "buy at market", he said he was willing to pay whatever the going rate was when the market opened.
When news breaks on a company, its industry or the overall market a massive pile of orders can hit the market at once, and the price of a stock can move very quickly. Meanwhile your order is queued up behind a whole lot of other orders. Under severe market conditions, an order that might otherwise get filled in only seconds actually takes several minutes (I've seen occasions where market orders take hours to fill). The price can fluctuate anywhere within those minutes and often does.Limit Order
To protect yourself against an unexpected move in price, you may consider placing a limit order instead of a market order. When you place a limit order, you set a specific price that sets a limit as to the highest price you are willing to pay if you are buying, or a limit as to the least you are willing to accept if you are selling.
You enter this order by selecting "limit" from the action menu, and then clicking in the text box next to "limit" and typing in your limit price.
The limit price on a buy order is usually either equal to or below the current ask price. It is an instruction to tell your broker to buy this stock if and when this stock falls down to the price you are willing to pay.
On a sell order, the limit price is usually set equal to or above the current bid price. It instructs your broker to sell this stock if and when the stock comes up to the price you want to receive.
A limit order has the advantage of making sure you the price you want. In fact, sometimes it's possible to get filled at an even better price. I've seen many buy orders were fulfilled lower than the limit price, and sell orders fulfilled higher than the limit price.
However, unlike a market order, there is no guarantee that your order will be fulfilled. A stock may not trade at the price you want to buy or sell. In fact (as I'll show you in Chapter 12), just seeing a stock trade at your limit price is not necessarily a guarantee that your order will go through.
Stop order
You might have heard them described as a "stop loss order". The term "stop loss" is discouraged because it can't actually prevent a loss, even though the name implies that you can. This type of order should be called a "stop" order, something that does not make a promise it can’t keep.A stop order is an order to buy or sell that only becomes active after the stock reaches or crosses the price you specified as your stop price. In other words, a stop price is a trigger price that means once your stock goes to or goes through your stop price, the buy or sell order becomes active and is fulfilled at whatever the best prevailing price is at the time.
How is that different from a limit order? Doesn't a limit order mean buy or sell when it reaches your price? I'll illustrate with a sell order, since that’s usually how stop orders are used. If you're selling, putting in a sell limit order means sell the stock when it comes up to (and for no less than) your specified price. A sell stop order means sell the stock when it falls down to your specified price (and get whatever you can for it) but not before.
So there are two important differences between limit and stop orders. First, a limit order means your brokerage must buy or sell only at your limit price, and if you can't get the price you want then your order won't go through. Once a stop order is triggered your order goes through at whatever the going price is at the time, and a stop order is triggered as soon as the stock hits your stop price.
The second difference has to do with where the price is set. On a sell limit order the limit price is usually set at or above the current price, but on a sell stop order the stop price is set below the current price.
Stop orders can be used on the buy side as well. It's the same thing, just in the opposite direction. The price on a buy limit order, as you know, is set at or below the current price, and on a buy stop limit the stop price is set above the current price. A buy stop order means buy the stock only if and when the stock goes up to or through your stop price. Once the stock trades at or goes above your trigger price, the buy order is activated and is fulfilled at whatever the prevailing price is.
Sell stops must always be entered below the current bid price and buy stops must be entered above the current ask price. You will get an error message if you don't. In case you forget which goes where, here's something to help you.
If you want to buy...
at or below the current price...
enter a Buy Limit order.
If you want to buy...
above the current price...
enter a Buy Stop order.
If you want to sell...
at or above the current price...
enter a Sell Limit order.
If you want to sell...
below the current price...
enter a Sell Stop order.
As soon as a stop order is activated (the technical term is elected) it buys or sells at whatever the best available price is at that moment. There is no guarantee of what price you'll get once the order is elected, it's just whatever you can get, but the order will be executed. Does that sound like something you've already heard? I hope so because I've just described a market order. So a stop order becomes a market order if and when the stock hits your stop price. Market orders are not guaranteed to price, so a stop order might be fulfilled at a price different from your stop price, especially if the stock's in a free fall. In fact, as you can see in this price chart, that a stock can gap significantly from one day to the next.
Order Qualifiers
You may also be able to add certain special instructions to your order as well. Order qualifiers let you modify your trade so that this particular order is handled somewhat differently than the way most orders are handled. Order qualifiers do not apply to market orders since they are executed immediately.