Thinking of investing in the stock market? For first-time investors, the process can seem daunting. Not only does investment require careful planning and research, but the actual purchase of stocks isn’t as simple as clicking a button.
It’s essential that investors understand the different stock order types available today. According to research published in Forbes, using the wrong type of stock market order can cost you money and deplete the efficiency of your investment.
In this post, we’ll cover the various stock order types and explain the advantages and disadvantages of each.
What is a Stock Order?
First things first, you may be wondering what a stock order actually is. While it’s easy to think solely in terms of “buying” and “selling,” a volatile market can change rapidly. When that happens, some investors may fall victim to something called “slippage.”
Slippage refers to the difference between the price you expect and the price at which the order is actually filled. If you’re not careful, this can result in a loss when you’re working with stocks.
This is why it’s important to consider more sophisticated types of stock orders. Different stock trade order types can minimize the risk of slippage and help you to maximize your investment.
Some stock orders can serve as a kind of insurance policy, enabling you to quickly jettison underperforming stock before you experience a catastrophic loss.
Types of Stock Orders
Let’s cover the five most common stock order types you’re likely to encounter as an investor.
Market Order
A market order is among the most common trading order types. In a market order, you purchase or sell a stock at the current market price. Notice that in this type of order, the price is controlled entirely by the market. So, for instance, if you want to purchase 5 shares of stock at $4,000 per share, your total market order will be $20,000.
This is an aggressive strategy, and it also poses a greater risk of slippage compared to other stock trading order types. If other investors have their orders executed prior to yours, the price could change by the time your order is executed, resulting in a higher price.
Of course, the clearest advantage of a market order is that it allows you to place the order immediately with no real lag time, other than the delays associated with the market itself.
But investors may still exercise caution by only placing market orders for relatively few (say, less than 100) shares at a time to minimize their risk of slippage.
It’s also possible that some brokers may charge more for market orders due to their immediacy, so make sure to ask about commission rates before making a trade.
Limit Order
A limit order works a bit differently. In a limit order, the investor sets the limit on the total price of the order. For instance, you might be willing to buy 5 shares of a company at $2,000 per share. This means you would never spend more than $10,000 on your total order.
The advantage of this is clear: It allows you to set clear, upper limits on your stock portfolio to avoid overspending or slippage. If a particular stock never reaches the desired price, the order will not be executed.
It’s also important to note that limit orders can come in two forms. Buy limit orders prevent buyers from paying more than an agreed-upon amount per share. This works just like our above example: If you want to buy 3 shares of Amazon stock at $3,000 per share, your sale will never be executed unless the stock price is at or below this amount, which means you’ll never pay more than $9,000 total.
Sell limit orders protect sellers from selling below a specific amount. For example, if you’re selling a particular stock, you can set a minimum price per share. The order is never executed unless a buyer offers you a bid at or above the price you set. This way, you’re never in danger of being short-changed when selling a particular stock.
This can be an effective strategy if you’re aiming to invest in a high-value stock or if you’re looking to purchase a large number of shares (e.g., 100 or more). It’s also ideal for those who intend to carefully monitor their budget when making investments, ensuring that they never exceed their desired investment limits.
Stop Order
A stop order is among the safer trading order types because it allows you to limit your loss on a particular investment. More specifically, a stop order sells a stock once it drops to a certain price, minimizing your losses.
For instance, if you’ve invested in a startup company at $10 per share, you can place a stop order if the stock drops to $6 per share. If the stock takes off, the order will never be executed. But if the startup company’s stock suddenly plummets, a stop order can save you from losing a larger portion of your investment.
Be aware, however, that this doesn’t guarantee that your stock will sell at that price. In the above example, it’s quite possible that the stock would plummet well below $6 per share. In that case, you would sell at the current market price. The point of the $6 limit is simply to set the conditions under which the order would be executed.
Many investors use stop orders for long-term investments, though a stop order can also be used with a short position.
But, as the SEC warns, sometimes a stop order can be triggered by price fluctuations that happen during the course of a given day. This means that the stock could potentially close at a higher price than the price that triggered the stop order.
To counter this, some brokerage firms have different standards by which a stop order is executed. Some rely on closing-day prices from the previous day, while others rely on quotation prices. Ask your broker about their criteria prior to committing to a stop order.
Stop-Limit Order
As the name suggests, a stock-limit order combines the features of a stop order and a limit order. In a stop-limit order, there are two moving parts: The stop price and the limit price. If the stock price matches the stop price, the order becomes a limit order.
It sounds a bit confusing, but here’s how it works practically. Imagine you currently own a stock trading at $20 per share. You would like to sell the stock if the price ever dips below $15 per share (similar to a stop order). But you don’t necessarily want to sell the stock unless the market price stays above $12 per share.
So, in our imaginary scenario, you own a $20 stock that drops to $12 per share. A stop-limit order turns into a limit order at this point, in the amount of $12 per share.
A stop-limit order therefore protects you from dropping stock prices, while also ensuring that you sell your stock for a price that you determine beforehand.
The greatest advantage of stop-limit orders is the high degree of precision you have in executing a trade, giving you more predictability in your overall gains and losses.
Trailing Stop Order
As we observed above, a traditional stop order sells your stock when it dips below a specified value. In a trailing stop order, the stock is sold based on the percentage of change in the market price. For example, if you’ve invested in a stock at a price of $20 per share, you can place a trailing stop order of 20%. If the stock drops by 20% or more, your stop-order would be executed and your shares would be sold.
As with the traditional stop order, this does not guarantee that the sale will be executed at the 20% mark. Stock prices can dip below this percentage. You will receive the price based on the current market value.
Trailing stop orders are typically used for a long position, but they can also be used for a short position. But as with stop orders, intra-day market fluctuations can trigger a trailing stop order. Investors should consult with their brokers to pinpoint the criteria at which a trailing stop order will be executed.
Find the Right Tools with Gorilla Trades
These stock trade ordering types can be great tools for any level of investor. But it’s also great to have a resource to help you select stocks, perform market research, and monitor your investments.
That’s why the experts at Gorilla Trades are proud to offer our clients the latest tools and updates so that you stay on top of industry updates and investment opportunities.
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