Before you hit the send order button, do the different order types make you confused?
Or have you ever wondered what is their purpose and how can they serve you?
Well, let us cover them in this article.
First, the market order.
Market orders aim for immediate execution at the best available price, but the execution price is not guaranteed.
It is crucial to note that the last-traded price might not match the market order's execution price, especially in fast-moving markets.
Investors favor market orders when the primary goal is to execute the trade immediately. While the exact price is uncertain, they ensure a prompt fill, making them advantageous.
This is especially true for stocks with high trading volumes because the market orders tend to be executed near bid/ ask prices.
Next, we have the limit order. I use this order type the most often.
A limit order sets a specific price or better for buying or selling a stock. A buy limit triggers at the set price or lower, and a sell limit activates at the set price or higher.
It executes only if the price reaches the designated level. But, placing a limit order does not guarantee execution.
Does that bother me?
Not really.
As I invest based on valuation, I need to use limit orders to control execution price, even though I know that the execution is not guaranteed.
Lastly, we have the stop order.
To add to the complexity, we have three kinds of stop orders: stop, stop-limit, and trailing stop orders.
I will explain each of them as simply as possible, starting with the stop order.
You set a stop order, also called a stop-loss, to automatically buy or sell a stock at a specific price.
Once the stock reaches that price, the stop order triggers and becomes a market order, executing the trade immediately at the best available price.
Unlike market orders, stop orders remain inactive until a specific price point is reached, and then they activate as market orders.
A stop order serves three purposes.
It safeguards gains on a rising stock. It sets a loss limit on a recently purchased stock. And finally, it lets you initiate a buy if a stock surpasses a specific level, indicating potential growth.
While the stop price triggers a market order, the execution price can deviate significantly, particularly in volatile markets or when there is a price gap.
To mitigate this risk, a stop-limit order can help though it may limit execution.
A stop-limit order combines stop and limit features, executing at a specified price or better once the stop price is met. It requires a stop price (activates order) and a limit price (sets execution cap).
The stop and limit prices can differ. For instance, a sell stop-limit with a stop at $3.00 and a limit at $2.50 becomes active at $3.00 but only executes at $2.50 or higher.
This grants control over execution price and safeguards against sudden price gaps during market turbulence.
However, as with all limit orders, a stop-limit order may not be executed.
Lastly, we have the trailing stop order. This order type is not so straightforward as the stop price is not fixed.
Instead, the stop price is either a defined percentage or dollar amount, above or below the current market price of the stock.
As the price of the stock moves in a favorable direction the trailing stop price adjusts or “trails” the market price of the stock by the specified amount. However, if the stock’s price moves in an unfavorable direction, the trailing stop price remains fixed, and the order will be triggered if the stock’s price reaches the trailing stop price.
For all three kinds of stop orders, investors must carefully select stop prices to avoid premature exits triggered by short-term market fluctuations.
Now you are an order-type expert! Feel free to reply to me if this article sheds some light (and how many "execute/ execution" words I snuck in – there might be a few too many!).