Market orders and how to use them

Like many other intricacies of the stock market business, there is an exclusive, precise language of accepted usage for placing orders, which at first sight appears confusing and foreign. Take the pieces of the language apart though, and it makes logical sense.

In the first place, we must remember an order you might place to buy or sell stocks, is your set of instructions directed to a trader on the floor. Your instruction must be clearly understood to eliminate ambiguity and the chance for error in carrying out your transaction. Then too, for the people in the business, such as the broker with whom you place your order, the system for placing orders must be efficient. Think of the number of transactions processed each day, and it clearly makes perfect sense to waste few words in passing on your instructions.

Buy orders are not always a simple order to make a purchase at what ever price the market is asking. It isn’t like walking into your local supermarket, selecting an item on the self and proceeding to the cash register where you pay the posted price. In that scenario, the consumer does not have any choice but to pay the price the seller has stated. In a moving, rapidly changing stock market, buyers and sellers have lots of choices about how they want to carry out a transaction, they know it, and will push to seek what it is they are after.

The simplest order type is a market order. Investors can place an order to buy or sell at market price. As long as there are buyers and sellers active in the specified stock, a buy market order or sell market order will be filled quickly because there are not any conditions which must be met to complete the transaction. The only problem with a market order is that once the order is placed, the buyer or seller loses control of the transaction. He does not know for sure at what price the deal will go through, but he is committed to completing it.  The customer can gain some control over the price at which a trade is to be carried out by placing a limit order.{mospagebreak}

Limit Orders

In a buy limit order the customer is simply stating he does not want to buy if the price exceeds his stated limit. The broker clearly understands he must not make a deal unless the price is at the limit or lower than the limit. With a sell limit order the broker is being instructed to sell at the limit or for a price that is higher than the limit. In this situation, the customer still doesn’t know exactly what he will be paying or receiving, but he does know his cap or limit will not be surpassed.

With this type of transaction, it may take longer to strike a deal or in some cases, a deal might not even be found. So, a further stipulation can be placed on a limit order to try accomplishing the objective of the order or at least a part of it. The limit order can be Fill or Kill (FOK), which means the limit order will be attempted one time only, might be filled completely or partially, then withdrawn. The limit order can also be stated as All or None (AON), which means the limit order must be filled completely not just in part. This type of order remains open with the broker until cancelled by the customer.

Orders With Accompanying Conditions

Stop Orders make it so that the customer does not need continually monitor the market for price levels. With stop orders, the buyer is specifying a maximum price level he is willing to pay for a stock or for sellers, the minimum price level at which he will sell his stocks. This does not mean the order will go through at the stop price and herein lies any confusion with the terminology which may exist for the novice investor. Just understand that when the stop price is reached, the stop order becomes a market order and the broker will be transacting at the next available price once the order hits the floor. In a moving market, prices change by the second. In a falling market, stop price buyers will likely pay less than the stop price. In a rising market, stop price sellers will likely receive more than the stop price. Now lets re-define this using market terminology.  Buy Stop Order is an instruction to the broker to make the purchase at the best price possible after the stop price has been reached.  Sell Stop Order is an instruction to the broker to sell at the best available price once the stop price has been reached.

Then, there is a stop limit order in which the order becomes a limit order once the stop price has been reached. This is in contrast to the stop order which, as previously mentioned, becomes a market order. By placing a stop limit order, a stated buy or sell price is applied just like in a limit order, but the limit order only goes into effect once the stop price has been reached.

There is one other type of stop order to consider before looking at how to put these orders to beneficial use in your market activity. Trailing Stop Orders are stop orders placed with an additional consideration. With these orders, the activation point is a moving or trailing (i.e., trailing the market) price which is entered either as a percentage amount of increase or decrease in the market price or as a specified amount of monetary increase or decrease in the market price. These are the only difficult orders to understand and time intensive to track because the stop limit is always moving. Don’t spend too much time trying to figure out Trailing Stop Order figures because they are rarely used. I mention them here only because they do exist and may come up from time to time in discussion. {mospagebreak}

Putting Stop Orders to Use

Because your order is placed to be activated only when the market reaches a certain price, the investor can limit their loss on specific security positions. Stop orders are also commonly called Stop Loss Orders. That name better describes the reasoning behind stop orders and their useful application.

A stop order or as we are referring to it here, a stop loss order, placed at 15% means the broker has been instructed to sell your stock if the price falls 15% below the price you paid for it, thereby keeping your loss to a more acceptable level. When setting an amount on your stop orders, give careful consideration to the historical performance of the stock in question. Lets suppose 10% is your “pain barrier” for being able to accept a loss without undue remorse. You might not be best served by placing that 10% figure to shares in a company which is known to fluctuate up and down quickly and over a wide range. You might find yourself unloading a stock too soon because it might recover from lets say, a 12% dip to post a 2% two day gain by the close of the very next day of trading. With shares such as these a 15% figure might be more appropriate.

Investors active in working Short Sales usually put buy stop Orders to very good use. A short sale is selling a stock you do not own in order to take advantage of a stock the investor believes is poised to fall in value. The way this works is an investor borrows some shares he will sell at market price in the hope he is correct and the price later falls. When the price does drop, he buys in order to replace the borrowed shares, and realizes the difference as profit. Now, he does this on the underlying assumption his guess is right, but he can take one step to help cover for error. By placing a Buy Stop Order if the price happens to rise rather than fall, he is instructing his broker to buy at the best available price above the stop price. Of course, this doesn’t mean the investor made any money, but it does mean he took measures to minimize losses.