Whether you are investing or trading, to take part in the action that you will need to issue orders to your broker, telling him what to buy or sell. There are different ways to express these orders so that you can make sure that your intent is followed.
The basic order to your broker is called a “market order”. This simply tells your broker to go out into the market and buy or sell the number of shares you request in the company you name at the best price he can. As I’ve said several times, prices fluctuate continually, so this may mean that the price is not quite the same as you expect, if you have been looking at the prices on the computer. But usually the price is fairly close, and some people only ever use this type of order. There are advantages in learning some others, as you’ll see.
Another commonly used type of order is the “limit order”. The idea of this one is that you want to buy or sell at a more favourable price than the current market price, or, depending how you set it, you want to make sure that you get the current market price and not one which has slipped in value against you. When you place this order, you also specify the price at which you will buy or sell.
Now if the price you specify is not available, then the broker will not make the trade for you. What will happen is that the broker will wait until that price or better is available, and then fulfil your order. You can usually specify Good Till Cancelled (GTC), which means if you do nothing else the broker will keep trying day after day to place this trade at your price until it is successful; or the order can be good for the day only, so if your price was not achieved in the trading day, the total order goes away unfulfilled.
This highlights the problem as well as the advantage of the limit order. The trade may never happen, if your price is not reached. Say you thought the price was going up, but you wanted to squeeze every last penny so you placed a limit order at the current price on your screen. Perhaps the broker would not be able to get that price, so your order could not be completed. You might be left watching the price creeping up, as you had already predicted, but with no ownership and no profit.
Another very popular type of order is called the stop order, or sometimes the stoploss order. This is most often used to protect your portfolio from too much loss. This time you place an order that will buy or sell at a less favourable price than the current price. Remember the limit order set a more favourable price for the trade.
At first, you might think it strange that you want to specify a worse price for the trade to happen at. But one way it is commonly used is to set a limit to a deteriorating price, or to set a level beyond which you don’t want to go. Prices go up and down all the time, and if you buy a stock thinking is going up and it doesn’t, then you want to sell it again before it loses too much money for you. The stoploss order allows you to do this. You simply issue the stop loss order when you buy the stock, and that makes sure that you get out of the position if it happens turn against you.
Despite its apparent advantage that you do not need to keep watching the price all the time, there are a couple of problems with the stop order. Firstly, if you set the price too close to the current price, you might find that the value is reached and the stoploss order is triggered on regular fluctuations. The price might dip, and then go up just as you had predicted, and you would lose out because the order took you out of the trade.
Another possible problem, if there is a serious turnaround in the fortunes of the stock, is that a stoploss order when triggered becomes a simple market order. If the price is going down quickly, you might not get a deal at the number you set, but something worse. With some types of trading, such as spread betting, you can get something called a Guaranteed Stop Loss, an order that guarantees the price you get if the stop loss is triggered, but it costs a little more in fees.
Another use of the stoploss is to enter a trade. For example, you might decide that a certain stock looks like it is going to surge upward in value, but only if it reaches a particular level above where it is currently trading (if you want to understand this concept, I recommend you study some technical analysis). When the price is reached, your stop order is triggered and you buy the stock. If you’re wrong, and the price never surges, then you have not placed any trades and you are not out-of-pocket. If you’re right, you gave up a little potential profit for the sake of not being in a trade that is not going anywhere.
Most traders will mainly use the orders explained above, and they are applicable to most situations. Three others can be useful – the trailing stop order, contingent order, and “one cancels the other” (OCO). The contingent order says that you only execute this order if and when another linked order is executed. For example, if you’re using a limit order to enter a trade, you could use a contingent order to set a stop loss if and when the limit order was triggered and you bought the stock. If you didn’t do this, you might find that the stop loss order triggered before you even had a shareholding, leaving you selling a stock you don’t own. (This can be done, as you will see below in “Shorting”, but it is something you want to do intentionally, and not by mistake!)
The OCO order might be used if you decided to use a limit order to exit a trade for a profit. You might also have a stoploss order should the trade go against you, and whichever way you exit the trade you want the other order to be cancelled.
The trailing stop order is a stoploss order with a variable price which follows or trails the market price, with the proviso that the value never goes back down. If the price falls after making a run up, the trailing stop order will ensure that you keep most of the gains.