Three Types of Stock Trades

Dealing shares without the help of a broker can be a bit intimidating at first. However, thanks to online brokers who offer inexpensive trades through the internet, many investors are taking the plunge into trading shares on their own. Often times, these traders do not realize that there are several different options available when placing an order and depending on the situation, something other than a standard order can be very beneficial. I’ll cover the various types of trades in this article.

Market Orders

The most common type of trade is called a market order, or sometimes simply a standard order. A market order is an order for a specific number of shares to be bought or sold at the best available price as soon as possible. The best available price is not always the price you will see quoted on a financial website, financial section of the newspaper or the television, however. The prices change constantly and there are different prices for buying shares and for selling shares.

The bid price is what a dealer will pay for a security, or what you will receive when selling, while the ask price is the amount for which the dealer will sell shares, or what you must pay when purchasing. The difference between the two is called the spread. Certain stocks have a wide spread, meaning there is a greater difference between the bid-price and the ask-price, while others have a narrow spread, meaning the prices are quite close together. However, the ask price is always higher than the bid, and more frequently traded stocks, or highly liquid stocks, will have a narrower spread, while less frequently traded stocks will have a wider spread.

Limit Orders

Sometimes, you may want to deal shares at a specific price, or know beforehand at what price the shares will trade. In this case, you have the option with most stockbrokers, even online brokers, to place a limit or better order, more commonly called a limit order. With a limit order, an investor can name a specific price at which they would like to buy or sell a number of shares in a specific equity. In placing a limit order there is no guarantee that the order will be executed at any time. Even if there were shares available at your given price, if there are not enough to fill all of the orders, your order may be too far down in the queue to be filled. Also, the shares may not become available at your given price at all, in which case the order would also go unfilled. Limit orders may be placed above the current market price when selling shares or below the current market price when purchasing shares.

For example, if the current market price of XYZ is £20, but you want to sell your 100 shares only when the price reaches £22, then you could place a limit order to sell 100 shares of XYZ at £22. Then, if the price rises to £22 or better and a matching order to purchase shares of XYZ at £22 (or market price if that is higher) then your sell order will be executed. If the price does not reach £22 or there are not enough shares available, then your order will expire. The expiration date is most commonly the end of the trading day; however, you may often specify an expiration date of sometime in the future (usually within 30 days).

Conversely, if you wanted to purchase 100 shares of XYZ when it reaches £18, then you would place an order to buy 100 shares XYZ, limit order at £18. Again, if the number of shares at the price you desire is not available, then your order will expire at the appropriate time.

Using limit orders can be a great way to ensure you are receiving the price you expect. However, it is important to realize that your order may not be filled at all or it may take some time to be completed.

Stop Orders

Another fairly common type of order is a stop order, sometimes called a stop loss order. Similar to limit orders, stop orders are made at a price above or below the current market price of a security. A stop order works in opposition to a limit order. A buy stop order would be placed above the current market price, while a stop sell order would be placed below the current market price. Sell stop orders are generally the more common of the two types of stop orders and it is used to minimize a loss on a particular equity. Another key distinction is that a stop order does not guarantee a price like a limit order does. Instead, if a stop price is hit, the order becomes a market order and will be filled as soon as possible at the best available price.

Let us take a look at an example of a sell stop order and why it might be utilized. Imagine you own 100 shares of ABC stock, which you purchased some time ago for £40. At this point the stock has not done well and it is now trading near £20 per share. You are afraid that if it begins to drop below £20 that it might just continue to drop and you have decided to cut your losses at that point, but you are still hopeful that the stock will recover before it reaches that point. So you decide to place a sell stop order for 100 shares of ABC at $19.99. As soon as the stock trades at £19.99 or below, your order will change to a market order and will be filled as soon as possible at the best available price. There is no guarantee on the price; it may in fact be higher or lower than £19.99. The stop order can also be used to lock in gains. For instance if instead, ABC stock was trading at £100 and you wanted to guarantee yourself a very good profit, you could set a sell stop order at £90 and still make a very comfortable profit on the shares.

A buy stop order is not often used by the average investor. It is most commonly utilized to minimize losses on short positions or to protect profits when selling short. Selling short is a somewhat advanced trading technique in which an investor sells a stock before actually purchasing it. Selling short can be a very risky proposition and should only be done by experienced traders with a proper portfolio behind them.

Although stop and limit orders are not utilized all that often by new investors, there are several scenarios in which they can be very useful. The cost of placing stop or limit orders is generally the same as a standard market order cost, but be sure to check the fee schedule of your stockbroker. Limit orders can be especially useful if you know a price at which you would like to trade shares but do not have time or the desire to watch the market closely. Each of the order types allows for investors to easily stay in control of their portfolio while continuing on with the important aspects of everyday life, such as work and family.