Whether buying or selling a stock, good investing requires knowing:
- when to place your order
- the risks associated with the order
- what you want your order to achieve
- the price at which you want to buy or sell the shares
There are several order types available to stock investors, including market orders, limit orders and stop-loss orders.
A market order is the simplest and most common type of order. A market order tells your broker to buy or sell a stock for you immediately at the best price. Since you do not specify a price, this type of order will almost always be filled, but it may not necessarily correspond to the current market price because the price may have moved by the time the broker executes the order, unless you have received a firm quote from a market maker.
Remember, with small companies or companies with limited free float (available shares), the actual price you pay for a stock may be considerably different to the indicated bid/offer price, unless you have received a firm quote from a market maker. For example, while a market maker might quote a broker a price for 2,000 shares, the client may want to deal only in 10,000 shares, which could affect the price materially.
Risks of market orders
Market orders can be risky for the novice investor if there is no firm quote because the market price of a stock may move up or down between the time you ask the broker to place the order and the time the order is finally transacted.
This can result in unanticipated gains or losses.
You place a limit order in order to buy or sell a stock at a price you specify (the limit) or better. A limit order to buy would be executed at the limit or lower, while a limit order to sell would be executed at the limit or higher. You always place a buy limit order below the current stock price, and a sell limit order above the current stock price.
Example of Limit orders
Suppose you wish to buy 500 shares of stock at GBP 30 or better. You place an order with your broker to "buy limit at GBP 30." If a seller who wishes to trade at GBP 29.80 is found, your order is executed, since this betters the limit of GBP 30. If a seller had been found at GBP 30 then your order would have been executed at the limit price of GBP 30. No execution will take place above this, however.
Fill or Kill limit orders
You place a Fill or Kill limit order when you wish to execute your entire order immediately at a specified price or better. If this order cannot be dealt in the market your order will be cancelled. This order type will avoid partial executions. Two executions completed on two separate days may incur two commission charges. Fill or Kill orders will ensure that if the entire order can not be executed immediately at the price you have specified, the order will be cancelled.
Example of Fill or Kill limit orders
Suppose you wish to buy 250 shares of stock at GBP 10. You place an order with your broker to "buy fill or kill at GBP 10." If a seller who wishes to trade at GBP 10 is found, your order is executed. If a seller had been found below at GBP 9, then your order would have been executed, as this is better than the limit price. If this order could not be filled immediately, it would be cancelled.
Risks of limit orders
Limit orders are useful when you have decided on the price at which you are willing to trade. They guarantee that you will not buy a stock for more than the limit price or sell at less than the limit price, provided that your order is executed.
You may, of course, never buy or sell; but if you do, you are guaranteed the limit price or better. So because limit orders are predictable, their risk level is lower.
One word of caution: limit orders do not guarantee execution. If the stock price does not move to the limit level, your order will not be executed.
A sell-stop order, also known as a stop-loss order, is designed to stop a loss. If you hold a stock that is declining in price, you might place an order to sell the stock if it hits a certain price. Therefore, a sell-stop is placed at a price below the current price trading in the market.
Example of Stop-loss orders
If the stock is trading at GBP 50, you might place a sell-stop order at GBP 46.50. This order will not be executed until the stock trades at GBP 46.50 or lower. Again, as soon as this happens, your broker will execute the order for you at the current market price.
Risks of stop-loss orders
The greatest risk associated with this type of order is that the order may be executed on one of the small price reversals that occur in the normal price movement of a stock. The stock may trade down slightly, thus activating the order at the sell price and liquidating your position. The stock may subsequently rise significantly, thus costing you profits. Another risk is that the order may be executed at a much lower level than the stop price if the market is falling rapidly.
Stop-loss orders allow you to limit your loss. If the price of a stock is falling and you do not expect it to make a dramatic recovery, then you might want to decide on a price at which you want to get out. The stop-loss order allows you to do this.
The contents of this tutorial are of a general nature. They are provided without liability and do not represent investment advice of any kind.