Monday, June 6, 2011

Your Orders, Sir?

This is going to be a very brief introduction to the types of orders you can make in order to purchase stocks and other similar securities like ETFs or mutual funds.

First off, if you look at or any other financial webpage, you can usually see the real-time (or close to real-time) prices of the stock market during trading hours (9:30am-4pm EST).  If you can imagine it, try picturing yourself walking in a supermarket.  As you go down one aisle, the stock aisle, you see all these different products and the price tags of each one changing every couple seconds by some cents.  This is kind of what the stock market is like during trading hours.  Prices fluctuate up and down.  Usually, big changes happen in between market hours so prices open (the price the stock begins the trading day with) at a much higher or lower price than the previous close (the price stocks ended yesterday's trading day).  Sometimes, when big economic reports or earnings reports come out, you can see a large spike or drop in a stock price in the middle of a trading day.

So how does this affect you?  Obviously, the price you buy or sell stock is very important.  There are several different types of orders that you can use with your broker: market, limit, stop, stop limit, market on close, and some other more complicated ones.

Market orders mean that you will buy the stock at the current market price.  There is some room for fluctuation since stock prices change every few seconds but most likely you will get the stock at the price you see or within one to two cents.  If you put in a market order during a time other than trading hours (over the weekend or at 8pm for example), your order will issue at the beginning of the next trading day.

Limit orders are orders where you specify a price to buy or sell a stock.  Once the price of the stock matches the price you put in for the limit order, if there is a trade for the number of shares you are asking for then it will transact.  Limit orders guarantee the price you ask; otherwise it won't occur.  For example, let's say you are looking at buying Walmart (ticker:WMT) which is currently at $53.66.  However, you think that some economic news coming out this week will be bad in terms of consumer spending which should hurt Walmart's stock price.  So you place a buy limit order at $50, set to expire at the end of the week.  If Walmart's stock price ever hits $50 within the week, your order will execute and you will then buy Walmart shares and pay your commission.  If it doesn't touch $50 this week, then it won't execute and you won't have to pay anything.  With limit orders, you get the trade you want but you run the risk of missing out on buying a stock that goes higher or selling a stock that goes lower since you were waiting for a better price.  But you do get to take advantage of the short-term volatility of a stock using this type of order.

Stop orders are like limit orders in that you specify a price.  However, after the stock price reaches your stop price, the order becomes a market order.  This can result in a slightly different price than you specified, but it means that you are more likely to get your trade to execute since it isn't as strict.  However, there is the risk of  selling a stock as it is crashing or buying a stock as it is skyrocketing and receiving or paying less or more than you actually want.  I would recommend sticking with limit orders but stop orders may be useful depending on the situation.

Stop limit orders combine stop and limit orders, understandably.  When the stop price is hit, the trade becomes a limit order, only executing if it can fulfill the shares you ask for at the limit price.

Market on close means you will buy the shares of your stock at whatever price the market closes at.

There are a few other orders available.  For example, there is OCO (One Cancels Others) in where you have two different trades set up and if the conditions of one are met and executes, the other oder is cancelled.  These are usually for more sophisticated investors and aren't necessary when starting out.

Limit and stop orders generally have a higher commission.  However, it always depends on the broker so this is not always the case.  TradeKing has the standard $4.95 regardless of order type so make sure you check with your broker to see if you can utilize some of these special orders at no additional cost.

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