Beginning traders often believe that there is only one way to enter a stock trade. You click on buy or sell on your computer and that is all there is to it.
Nothing could be further from the truth! Believe it or not, there are over 40 unique order types available to the stock trader. Each type serves a unique purpose in presenting your order to the market and is used in specific circumstances. Orders with esoteric soundings names like Fill or Kill, Iceberg and VWAP provide the active stock trader with an almost unlimited smorgasbord of choices.
These different order types can be divided into three primary main categories: Market Orders, Limit Orders, and Stop Orders. This article will review these three primary categories, look at several sub categories and discuss the best time to use each type of order when trading.
Just Meet Me in the Market
Let's start with the simplest and easiest to understand order type, the Market Order.
Market orders are generally the fastest way to get your order filled. The downside is that the price at which your order is filled not fixed.
When you use a market order, you are basically tossing your buy/sell order into the market hoping to get the last quoted price.
Most of the time this works, filling you at or very close to the price you saw just prior to entering the order. However, during volatile market conditions, market orders are sometimes filled far away from the price you expected. For this reason, when speed of execution is critical, when you care more about getting in (or out) of a market than you do the price at which you get in (or out) of a market, market orders are the way to go.
Various types of market orders include: All Or None, Market If Touched and Market On Open/Close. All Or None prevents Market Makers at the stock exchange from filling your trade order in piecemeal fashion, at different prices. With the All or None order, your trade is either filled completely or not at all. All Or None orders can be used with limit orders also.
Market If Touched is in order that is held on your execution platform or at your broker until a certain price is touched. Once the price is touched, the order is released into the market as a Market Order. Market On Open/Close orders are sent to the market at the open or close in expectation of being filled at the best opening (or closing) price.
Know Your Limitations
Limit Orders are just what they sound like: they require the market to fill your order at a specified or limited price.
Limit orders are best used when you need exact control over the price at which you are willing to be filled. The downside to using limit orders is that you will not get filled at all if the market does not reach your pre-set, limit price—even if the market trades just a tick away from the limit price.
Several of the subsets of Limit Orders include Limit If Touched, which enters a limit order into the market when a certain price or other criteria is touched. My favorite order type is also a subset of the limit order: the Bracket Order.
Bracket orders limit your losses and assist in locking in profits by placing two opposite side orders with the exact quantity as the original order.
Here is an example of a buy side bracket order that could be placed right now in Apple (AAPL | news | PowerRating | PR Charts ). Apple was purchased at 164.50, immediately a stop order was placed at 164.25 and a sell limit order was placed at 166.25. The stop order and the sell limit order provide both a loss-limiting exit and a profit-taking exit, effectively "bracketing" the entry.
Another widely used order type in this category of orders is the Discretionary Limit Order. The discretionary limit order is a limit order in which the trader defines an amount which increases the price range over which the order can be executed.
Discretionary limit orders are normally used in high volatility trading environments where the chances of getting executed are increased by the discretionary factor in the limit order. Here is an example using Yum Brands (YUM | news | PowerRating | PR Charts ). I want to buy this stock at 39 but will accept any price up to 39.25, therefore a discretionary limit order is placed at 39 but with the ability to be executed up to plus .25.
Stop in the Name of Loss
Stop orders are perhaps the most important order type in all of stock trading. Simply put, stop orders keep you from getting wiped out should the market or your stock move against your position.
To use a stop order, all a trader has to do is set a price at which a Market Sell Order will be sent to the market. Stop Limit Orders will transmit your order to the market but only execute at a preset price-the limit price-or better. Be careful, however. In vicious, fast moving markets, price often blows right through stop limit orders leaving the trader in a precarious position.
Another common stop order is the Trailing Stop order. A trailing stop order is a stop order that follows the price of the stock at a certain, preset increment, thus "trailing" the stock. A trailing stop locks in continual profits until prices fall back, hitting the trailing stop level.
I could easily write an entire article on each one of these types and subsets of orders. It's a fascinating and critical subject for the trader to master. However, this article provides a basic, cursory review of the primary order types for stock traders.
Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.
