As a trader, placing an order looks simple because all you have to do is click on the buy button or sell to enter a trade but it’s not quite that simple with all of the order types available and the different ways you can utilize them for your trading style.
Below we will go over three of the most important order types that every trader or investor should know and they are:
- Limit Order
- Market Order
- Stop Order
Here is an in-depth look at the above orders and how they work.
A limit order is one that allows traders to buy or sell a security at a specified price. What you need to know is that a buy limit order can be initiated at a particular limit price or lower while a sell limit order can be executed at a particular limit price or a higher value.
Let’s assume you are prepared to make an order to purchase 2,000 shares of Company X at a limit price of $100.65. What this means is that you want to purchase Company X shares when the price lowers to the limit price above. Despite the strategy above, the downside to your plan is that there may not be enough buyers to allow the price to go up. This does happen to sell limit orders too.
To counter this downside, it’s wise to set your price a few cents below the bid thus selling or purchasing your shares at the best available price.
Traders have the option of setting a marketable limit order. This new order type can help you to place a buy limit order valued above the ask which means it will get filled up only up to that price. Using the above example of Company X, set a buy order at $100.70 where the ask is $100.68.
As a trader, you have the opportunity of filling an order using the market order. As a reliable method designed to help you get in and out of a trade quickly, it allows you to purchase or sell at the best available current price. To better understand how a market order works, let’s assume we are planning to purchase 2,000 shares of Company A at the current market price – $100.65.
If we place a market order to sell the above shares then we will get filled at current bid and if we have more shares than what’s available then we will move to the next price down. That is called slippage and is one of the main concerns with using market orders.
When placing a market order, exercise caution especially if the stock is moving quickly or has a thin bid or offer because you could get filled at a much different price than you were expecting.
This is another type of order that allows you to enter and exit a trade quickly. A stop order instructs the trading system that you want to get in or out of a trade only when the price of a security is equal to your stop price. When this happens, the stop order becomes a market order thus it will continue executing at the next price. Traders use stop orders to protect themselves against long and short positions.
Using our earlier example of Company X which was trading at the current market price of $100.65, you can learn how a stop order works. Let’s assume you want to take a long position on Company X. To protect this position, set a sell stop order that will trigger if prices attain the sell stop order price. As a result, the trading system will enter a market order afterwards closing your position. Just like sell stop orders protect traders on long positions, buy stop orders protect traders against short positions.
Understanding how these order types work will help you become a more versatile trader but if you have never used them before then make sure to practice them first in a simulator!