What are the most commonly used order types for online stock trading? They are: market orders, limit orders, stop orders, and trailing stop orders.
Let’s take a quick dive into each order type and break them down one by one. PS – Make sure you have the best online broker to trade with!
A market order is most similar to a “buy it now” button on Ebay. When you use the buy it now button, you are buying that item, NOW. This is same concept of the market order, which basically says, “buy me (or sell) my shares now at whatever the best price is available at this very moment.”
So, if we were to buy stock with a market order, then we would get our shares at (or close to) the ASK price at the time of the order. Similarly, if we were to sell shares of stock with a market order, then we would get our shares sold at (or close to) the BID price at the the time of the order.
The ASK price is the lowest price a market participant (you, me, hedge fund, etc) is willing to sell their shares for at that moment, and the BID is the highest price someone is willing to buy shares (you, me, hedge fund, etc) for at that moment.
Tip for success: If the stock is very lightly traded (not a lot of people buying and selling shares) then you have to be careful when using market orders. Why? Because the bid/ask spread may be wide, which means you may not get a very good price. This is why people use limit orders (see next!).
Limit orders are stock orders that allow you to buy (or sell) shares of stock at a pre-designated price OR better.
Example: So let’s say we want to buy 10 shares of Microsoft (MSFT) stock, which is currently trading at a last of $123.37 per share, but we only want to pay $123.00 or less for our shares. What we can do is fill out a trade ticket for a buy limit order at $137.00, which basically says, “Hey, I know Microsoft is trading above $123 per share right now, but if the price comes down to $123 or lower, automatically buy me in please”. This same concept applies for using limit orders to sell shares of stock.
When you place your limit order, you can set the duration to have the order expire at the end of the day, end of the week, end of the month, or a year later. Also, the order is automatic, so you do not need to be present when the order takes place. Your online broker will fill it for you automatically and send you the confirmation notice.
Tip for success: Limit orders provide seasoned traders a lot of control over their trading, because they dictate price. Using limit orders is how you are able to place trades during pre- and post-market hours. You cannot use market orders during after hours trading.
Stop orders work like an insurance policy, they only trigger if your preset event (e.g. a stock hitting a certain price) occurs. They are most frequently used as a stop loss order to limit your downside risk.
Example: Let’s say you hold 100 shares of company XYZ at $100 per share and you don’t want to lose more than 10% of your investment. To protect yourself, you would place a stop market order (stop order + market order) at $90, which means yours shares will automatically sell if stock XYZ falls below $90 per share (10% of $100) at any time. Thus, you have effectively put a cap on your losses.
There are two types of stop loss orders, stop market orders and stop limit orders.
- Stop market orders will automatically sell the shares allotted at “the market” once the order is activated. See example above.
- Stop limit orders will automatically place a limit order whenever the trigger price is hit. When placing a stop limit order, you need to set the stop price AND the limit price. So using our same example, we could set a stop limit order at $90 / $90.10, which would effectively say, “if stock XYZ hits $90 per share, automatically place a sell limit order at $90.10 per share. As you can imagine, there is more risk doing this. With a market order, you are sold at $90 and walk away, with a limit the stock has to move back up to $90.10. What if it keeps selling off and the shares fall much further?
Tip for success 1: While stop losses are a great tool, they also can be dangerous if a stock decides to “trade through” an investor’s live stop loss order. “Trading through” means that the stock did not hit the preset stop loss price to trigger the order to sell, resulting in the stock continuing to fall without the investor knowing.
This commonly occurs when a stock “gaps” down after the market close because of earnings or similar big news. If a stock closes at $100 a share with a stop loss at $99 but opens the next morning at $95 because of bad earnings, the investor still holds their full position because the order never triggered. Thus, it is important to check up on a position once or twice a day to avoid this dilemma.
Tip for success 2: Never assume a stop loss order has been filled successfully. Always double check the trade confirmations page with your broker to confirm the order was filled in its entirety.
Tip for success 3: Set the trigger price at common price increments. Prices like $100 or $99.50 are far more common to be traded at than $100.37. By placing the trigger price at a common increment there is a MUCH smaller chance of the stock “trading through” the order.
Trailing Stop Orders
The least commonly used order types of the four, by far, is the trailing stop order. It is only used when you already hold shares of stock (active position) that is profitable and you want to lock in increased profits as the stock rises.
The whole point of a trailing stop order is to protect yourself on the downside, while continuing to give yourself room to profit on the upside.
The concept behind these orders is very simple. The order uses a set percentage or dollar $ value to calculate when to trigger a preset stop market order. The activation price automatically changes as the stock moves higher.
Example: You hold 100 shares of stock XYZ at $100, and the stock is currently trading at $110. You want to let the stock run higher, but don’t want to risk the stock falling back too far. To protect yourself but still give yourself room, you set a 5% trailing stop market order. So, at the time you place it, the activation price is $104.50 ($110 – 5%). As the stock moves higher, the price automatically adjusts, so at $111 the activation price is then $105.45 ($111 – 5%). Once the activation price hits and the order is triggered, a market order is simply placed automatically and your shares are sold.
While the activation price can RISE, is cannot FALL. Using the example above, once stock XYZ hits $111 a share, our trailing stop loss order is set at the new $105.45 price. It CANNOT go lower than that. As the stock rises, our activation price RISES; however, it doesn’t matter how fast the stock falls, our activation price will not adjust unless the stock sets a new price high.
Tip for success: It is important to give the stock enough room to move around naturally, as stocks don’t always JUST go up. For example, a 1% trailing stop order is far more likely to get triggered prematurely than a 5% trailing stop order.