Here’s a post that’s geared towards new investors, but experienced investors may find it helpful as well. I want to discuss the different types of orders you can make when buying or selling a stock. Investors have lots of options at their disposal, and each decision has an upside and a downside. Let’s start with your basic market order.
This is the most common type of stock order. In essence, it’s a request to buy or sell a stock at the current market price—hence the name. A market order does not guarantee a particular price; it merely picks up, or dumps, the stock at the current going rate.
What does this mean in concrete terms? Well, for large-cap stocks with heavy volume, you can expect that because market orders are executed more or less instantaneously, there shouldn’t be much of a gap between the price at the moment you execute the trade and the actual price you pay. If you see on your computer screen that the current price is $30 and you execute a market buy order, you might pay $30.10, you might pay $29.50, but the price will generally be close to the one you saw when you pulled the trigger.
The danger, however, lies in trades executed after hours. If you place a market order after the 4 p.m. closing bell, you may find the stock has moved significantly by the time the market opens the next morning. You can easily end up paying a price you didn’t bargain for. A $30 stock may have gapped up to $35 due to an earnings report or a merger announcement. News stories can cause prices to soar, or tank, so be wary: you don’t want to be on the receiving end of one of the market’s irrational spikes.
Another tip: don’t be distracted by irrelevant information. The last-trade price is no guarantee of anything. Ignore it. Instead, if you’re buying, keep your eye on the ask price. If you’re selling, look at the bid price. Also important is the spread between the bid and the ask, which can be very wide indeed on thinly-traded stocks.
With these less-popular securities, you may find the following conditional orders more helpful:
A limit order is an order to buy or sell a stock at a price that you yourself stipulate. Basically, it tells your broker to execute the trade once the stock goes above or below a specified threshold. You can use it to sell a stock once it climbs to a certain peak (thus guaranteeing you a profit) or to buy a stock once it dips to a certain low (thus guaranteeing you a good purchase price).
For example, you’re interested in security XYZ, but you think it’s currently overvalued at $40. You can place a limit order to pick it up at $38. If the stock falls below that threshold, the order will automatically execute and the stock is yours. Later, having acquired the stock, you can execute a limit order to sell it at $45. This order, too, will execute automatically if the stock gaps up, thus ensuring you a tidy profit.
Limit orders have advantages and disadvantages. On the plus side, you can keep them open for a set period of time, and they’re useful for investors who don’t have the ability to monitor their portfolios 24 hours a day. On the downside, if the limit price you set is way off the mark, it’s possible the stock may never reach the threshold and the order will never execute. For that reason, many brokers charge more for limit orders: failed execution means no commission for them.
Also, remember that orders are filled on a first-come, first-serve basis. If you set that limit order at $45, you have to wait till the other orders at that price are executed. Some traders like to snip at the edges and place limits at, say, $44.99, thinking they’re getting an edge on the competition. You can never be guaranteed that your order will be filled.