'Buy' to initiate a trade or 'Sell' to close a trade
'Buy' to initiate a trade or 'Sell' to close a trade
Placing a trade order seems intuitive – a “buy” button to initiate a trade and a “sell” button to close a trade. Although executing trades are possible in such a way, it is very inefficient as it requires constant monitoring of the stock. Using just the buy and sell buttons can result in spillage – the difference between the price expected and the price at which the stock is actually filled at.
When trading stocks that are highly volatile or trading in a fast-moving market, slippage can be the difference-maker between a winning and losing position. Therefore, understanding trade orders beyond the traditional “buy” and “sell” is very important.
When placing a trade order, there are five common types of orders that can be placed with a specialist or market maker:
A market order is a trade order to purchase or sell a stock at the current market price. A key component of a market order is that the individual does not control the amount paid for the stock purchase or sale – the price is set by the market. A market order poses a high spillage risk in a fast-moving market. If a stock is heavily traded, there may be trade orders being executed ahead of yours, changing the price that you are paying.
For example, if an investor were to place an order to purchase 100 shares, the investor would receive 100 shares at the stock’s asking price.
A limit order is a trade order to purchase or sell a stock at a specific set price or better. A limit order prevents investors from potentially purchasing or selling stocks at a price that they do not want. Therefore, in a limit order, if the price is not in line with the limit order price, the order will never execute. A limit order can be referred to as a buy limit order or a sell limit order.
A buy limit order is used by a buyer and specifies that the buyer will not pay more than $x per share, with $x being the limit order set by the buyer.
For example, consider a stock whose price is $11. An investor sets a limit order to purchase 100 shares at $10. In this scenario, only when the stock price hits $10 or lower will the trade execute.
A sell limit order is used by a seller and specifies that the seller will not sell a share under the price of $x per share, with $x being the limit order set by the seller.
For example, consider a stock whose price is $11. An investor sets a limit order to sell 100 shares at $12. In this scenario, only when the stock price hits $12 or higher will the trade execute.
A stop order, also referred to as a stop-loss order, is a trade order designed to limit (and therefore protect) an investor’s loss on a position. A stop order sells a stock when it reaches a certain price. Although a stop order is generally associated with a long position, it can also be used with a short position. In that case, the stock will be purchased if it trades above the stop order price.
For example, an investor is considering selling its position in a stock if it declines to $8 from its current price of $12. The investor could place a stop order at $8. When the stock hits $8, the order would be executed.
Note that the stock will not necessarily sell at exactly $8 – it depends on the supply and demand of the stock. If the stock price is rapidly falling, the order may be executed at a price significantly lower than $8. This type of problem can be minimized by a stop-limit order.
A stock-limit order is a conditional order that combines the feature of a stop and limit order. A stop-limit order requires placing two prices – the stop price and the limit price. Once the stock hits the stop price, the order becomes a limit order. Stop-limit orders, as opposed to a stop order, guarantees a price limit. On the other hand, a stop order guarantees an order execution but not necessarily at the stop order price.
For example, an investor currently owns a stock trading at $30. The investor would like to sell the stock if it dips below $25, but only if the stock can be sold at $24 or more. The investor sets a stop-limit order by setting a stop price of $25 and a limit price of $24. Once the stock drops below $25, the order becomes a $24 limit order.
A trailing stop order is similar to a stop order. However, a trailing stop order is based on the percentage change in market price as opposed to a specific target price. Although a trailing stop order is generally associated with a long position, it can also be used with a short position. In such a case, the stock will be purchased if it increases by a determined percentage.
For example, an investor purchases a stock at a price of $10. The investor places a trailing stop order of 20%. In the stock declines 20% or more, the order will be executed.
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