At the start of the year I did a blog post on favorite investment sayings. One I didn't include -- that I believe is a Dr. Don original -- is: "Investors sell at the bid and buy at the offer, that's how Wall Street fills its coffers." Stocks are quoted with a bid-ask (offer) spread. In liquid markets that spread is usually a penny. Placing a market order to buy shares will be filled at the ask price. Placing a market order to sell shares will be filled at the buy price.
What got me interested in order types as a blog post was an investment professional saying that he always used limit orders in trading exchange-traded funds (ETFs), exchange-traded notes (ETNs) and stocks to control the purchase (sale) price. A limit order can help investors avoid surprises when the market for a stock moves in the time it takes to place and execute a trade.
A limit order to buy shares establishes the price that you're willing to buy a quantity of shares of a stock. The trade doesn't get executed until that price is available. If Bankrate (symbol:RATE) stock is trading at $16.00 (bid) x $16.01 (ask), and you put in a limit order to buy 100 shares at 15.90, the trade won't be executed until the market reaches that level for the ask price. You can place the limit order as a "day order," good until that day's market close, or a "GTC" trade which means good til canceled.
What's the downside?
The stock may never get to that price. You may have to pay more in brokerage commissions on a limit order. You may get your order filled at your price only to see the stock fall below your fill price on news, leaving you in a losing position. Investors swear by limit orders as a way to control what price they get filled at but there's still investment risk.
There are a host of other order types that can be right for how you invest. The Security and Exchange Commission's Investor Bulletin, "Trading Basics: Understanding the Different Ways to Buy and Sell Stock," lays the most common ones out in just three pages. Here are a few more order types from that publication:
A stop order, also referred to as a stop-loss order, is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order. A buy stop order is entered at a stop price above the current market price. Investors generally use a buy stop order to limit a loss or to protect a profit on a stock that they have sold short. A sell stop order is entered at a stop price below the current market price. Investors generally use a sell stop order to limit a loss or to protect a profit on a stock that they own.
A stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order. Once the stop price is reached, a stop-limit order becomes a limit order that will be executed at a specified price (or better). The benefit of a stop-limit order is that the investor can control the price at which the order can be executed.
I'll admit to using market orders when I'm more concerned about missing the opportunity to own the stock than I am about the fill price for a stock with good liquidity. I use limit orders with stocks that are less liquid, or if I have a target price for owning the stock. As I pointed out in an earlier post, I'm a fan of the trailing stop that can keep you in a stock that's trending higher until the trend stalls out, however you define a stalling trend.
What type of orders do you use and when do you use them? Along with the SEC publication, read the Bankrate feature, "Try limit orders to tame stock trading risk."
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