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Basics of Investing & Portfolio Management

Hello there! Welcome to Your BullGlobe Lesson

Trade Order Types

Lesson 9

In this section, we will explain what orders are, how they work, what types there are, and what they are used for.
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Types of Trade Orders

You have developed a portfolio strategy and chosen the assets that you want to invest in to achieve your goals. Also, you have created a brokerage account with the broker that fits your needs the best. Now it is the perfect moment to execute your portfolio; and to do that, you will have to place your orders to your broker.

In this section, we will explain what orders are, how they work, what types there are, and what they are used for.

What are trade orders?

Simple. A trade order is essentially an instruction to your broker about how you want them to execute your trade.

Back in the day, these orders took place in physical locations called trading floors. Traders had to make complex hand signals and fight other traders to be able to execute orders.

Nowadays, it is as easy, painless, and quick as clicking a button or two.

How does a trade order work?

It is pretty simple in theory. Here are the basic steps of how it works:

  1. Select the asset you are interested in trading
  2. Click on trade (buy or sell)
  3. Select the amount you want to trade (if it is a sell order, it may prompt you to sell the full amount you bought):
    • Units: number of shares you want to buy or sell (all brokers have that feature)
    • Amount: the amount of capital you want to invest (or divest) in the asset (not all brokers have this feature)
  4. Choose the type of order you want to execute
  5. Click on Set Order (or something like that)
    • Your broker will try to fill the order as quickly and efficiently as possible

Depending on the type of order you placed and the asset you are intending to trade, it may take a while for your order to get executed or it may not be executed at all.

The thing is, there are many moving parts in the markets and things are changing constantly. Many factors affect the speed and the price at which trades are executed. So it is important to set the right order type to get the trade that you want.

Order types

As we said, there are multiple types of orders out there, and choosing the right one can help you to get in (or out) at the right price, at the right time, and even to minimize losses or maximize gains.

Market order

This is the simplest and most commonly used type of order. It is an order to buy or sell a security as soon as possible and at the next best available price.

A market order guarantees that your order will be executed ASAP but it does not guarantee the exact price you will get.

As long as there are willing sellers or buyers, it is likely that your market order will be executed at or pretty close to the last-traded (current) price. However, it is important to understand that the volatility and the trading volume of the security may affect the price at which your order will be executed.

With this type of order, it is essentially the same as if you were going to the supermarket and were buying fish, vegetables or anything else at its listed price.

How it works:

  1. Pick a security in your brokerage account
  2. Choose the number of shares you want to buy or sell
  3. Select market order and click to place the order
    1. It will be filled ASAP

Let’s see an example to clarify this:

You want to buy 1 share of Microsoft as soon as possible. It is 10:30 AM and the current price per share is $180, this is the latest price that was paid to buy a share of Microsoft.

Since Microsoft is a very popular company in the stock market, its volume of shares traded daily is huge (it is very liquid). Also, its price is typically not very volatile. So you may be able to get your order fulfilled almost instantaneously and very close to the price you wanted. The result of your order would look like this:

  • Order filled at $10:30:15 AM (delay of 15 seconds)
  • Price paid: $180.03 / share (price difference 0.016%)

Now, let’s imagine you want to buy 100 shares of Genius Brands as soon as possible. It is 10:40:30 AM and the current price per share is $3.

This company is very little and not popular at all, so its trading volume is nowhere near Microsoft’s. In addition, its share price has been extremely volatile, swinging from $7/share to $0.5/share in 3 years. Therefore, you are likely to get a very different result if placing a market order:

  • Order filled at 10:41:45 AM (delay of 1 minute and 15 seconds)
  • Price paid: $3.70 / share (price difference of 23.33%)

If we look at the price of 1 share, the difference may not be so noticeable. But if we are trading large amounts ($100,000 or $1,000,000, or higher) worth of stock, that slight difference in price really matters.

A market order may be the best choice for you if you are concerned with the timing of your order and not so much with the exact price you get.

This type of order has the best chance of being filled but it has the risk of being filled at a completely different price. Therefore, it is recommended that you use this type of trade when you are dealing with liquid assets, as we saw in our example of Microsoft vs Genius Brands.

Limit Order

This type of order is useful if you are more concerned about getting the right price than about the timing of the execution of your trade.

Limit orders are orders to buy or sell securities at a specific price or better (limit price). These orders are seen by the market and they are only executed when someone else is willing to meet your limit price.

With this type of order, it is almost as if you were trying to bargain with the market (like if you were trying to get a good price for fish or vegetables) by letting the world know what you think is the right price for the security (the limit price) and expecting the market to accept it. Therefore, it is important to be reasonable about the limit price you want. Otherwise, the chances of your order getting filled are slim to none.

  • Buy limit order

It will only execute if the price of an asset goes down to a specified limit price or lower. That means you only want to buy that asset for that price or cheaper.

How it works:

  1. Click on a security in your broker’s account
  2. Choose the number of shares
  3. Select “buy” and “limit order”
  4. Set a limit price under the current price
  5. Pick an expiration:
    1. Good for day: expires if canceled at the end of the trading session
    2. Good till cancel: expires if canceled or after 90 days
  6. Click to place the order
    1. Order may get executed

The above graph represents what a buy limit order would look like. In this case, you set the limit order to buy Microsoft stock at $180 or lower. As we can see, it took a few days for the order to execute because the price remained above your limit price of $180 until it moved down to $177 eventually.

  • Sell limit order

It will only execute if the price of an asset reaches a specified limit price or higher. That means you will only sell the asset for that price or for a higher price.

How it works:

  1. Click on a security in your broker’s account
  2. Choose the number of shares
  3. Select “sell” and “limit order”
  4. Set a limit price above the current price
  5. Pick an expiration:
    1. Good for day: expires if canceled at the end of the trading session
    2. Good till cancel: expires if canceled or after 90 days
  6. Click to place the order
    1. Order may get executed

The above graph represents what a sell limit order would look like. In this case, you set the limit order to sell Microsoft stock at $190 or higher. As we can see, it took a few days for the order to execute because the price remained below your limit price of $190 until it moved up to $190 eventually.

Limit Order Flaws

As we have seen, this is a really useful tool when you are anticipating an asset will reach a certain price and you want to take advantage of the move.

However, it has a few flaws that you should take into account:

  1. It may take hours, or even days to execute (depending on your settings). It is also possible that it never gets executed.
    • For instance, you want to buy Genius Brands stock at $3/share or lower, but the current price is $4/share; so you set a buy limit order at $3. However, the price of the stock goes up to $4.50 and it fluctuates around that price for 2 months. Your buy limit order will not get executed for at least those 2 months.
  2. You may incur some opportunity costs, which is the loss of potential gains had you chosen another type of order or kept the asset longer.
    • For instance, you may want to sell Microsoft stock at $190/share or higher, so you set a sell limit order at $190. The price reaches $190 and your sell order is automatically executed. However, after it reaches $190, it continues going up until $220.
      • You lost $30/share ($220 – $190) in potential gains.

Stop Order

This trading order is helpful if you are concerned about the price more than about speed.

Stop orders allow you to set an activation price that will place a market or a limit order. The activation price works as a trigger that will tell the broker to place an order of your choosing.

With this type of order, it is almost as if you were at the market, saw a few people bargaining for the price of fish and you were waiting for the price to get to where you want it in order to buy it directly or to start bargaining yourself. 

There are three types of Stop orders:

Stop Market Order

A Stop Market Order allows you to set a stop price (activation or trigger) that triggers a market order, which will tell the broker to trade the security at the next best available price.

Example:

You want to buy 1 share of Microsoft stock with a current price of $183. You believe that Microsoft stock value may decrease a bit in the near future, which may be a good opportunity to buy the stock. So you set a Stop Market Order with an activation price of $180. This means that if the price of Microsoft stock reaches $180, a market buy order will be automatically placed.

As we see above, Microsoft stock fell to our stop price, which triggered the market order at $180. Then, your market order was executed at $179, and from that point forward, you owned the stock.

Stop Limit Order

A Stop Limit Order allows you to set a stop price (activation or trigger) that triggers a limit order, which will tell the broker to trade the security at a specific price or better.

Example:

You want to buy 1 share of Microsoft stock with a current price of $183. You believe that Microsoft stock value may decrease a bit in the near future, which may be a good opportunity to buy the stock because you think it may go right back up. So you set a Stop Limit Order with an activation price of $180. This means that if the price of Microsoft stock reaches $180, a limit buy order will be automatically placed.

As we see above, Microsoft stock fell to our stop price, which triggered the limit order with a limit price of $179. Then, your limit order was executed at $179, and from that point forward, you owned the stock.

Even though this type of order is really useful, it has some of the same issues as the market order and as the limit order. For instance:

  • If you placed a Stop Market order to sell stock and its price is falling a lot and very fast, your sell order may be filled at a price much lower than what you hoped.
  • If you placed a Stop Price order to sell stock and its price is falling very quickly, you run the risk of your stop price triggering the limit order but that order never being filled if the price falls well below the limit price.
  • If you are buying securities, the reverse issues may happen. You may end up buying at a much higher price or never getting your order executed.

Trailing Stop Order

This type of order is a bit more sophisticated and some discount brokers may not offer it. However, it may be a great tool for you to lock in profits as a security’s value rises.

With this type of order, you can set a percentage or dollar amount away from the price of the security. This is called the trailing amount because it is dragged up by rising prices at the set distance. 

Example:

You are holding 1 share of Microsoft valued at $180 when you decide that you want to protect your gains but don’t want to sell the stock right away. So you set a Trailing Stop order to sell your stock if it ever decreases by more than $5 from its previous high point.

The above chart shows how a trailing stop order would work. The price of the stock rises up until $190, and the trailing price follows it setting the bottom limit at $185. When the price starts decreasing and it crosses the trailing stop price ($185), a sell order is automatically placed and you are out of the stock.

All the order types we have seen have their good things and their bad things. It is important to have your objectives in mind when choosing an order type because it can either help you get to your goals or work against you.

In the next section, we will be discussing the role of taxation in investing.

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