quote you prices, but because the markets move fast, with deals taking place in seconds, you’ll probably find that the price you’re quoted rarely is the same as the execution price. Whenever you place a market order, especially if you’re seeking a large number of shares, the probability is even greater that you’ll receive different prices for parts of the order – 100 shares at $25 and 100 shares at $25.05, for example.
If you want to avoid buying or selling stock at a price higher or lower than you intend, you must place a limit order instead of a market order. When placing a limit order, you specify the price at which you’ll buy or sell. You can place either a buy limit order or a sell limit order. Buy limit orders can be executed only when a seller is willing to sell the stock you’re buying at the limit price or lower. A sell limit order can be executed only when a buyer is willing to pay your limit price or higher. In other words, you set the parameters for the price that you’ll accept. You can’t do that with a market order.
The risk that you take when placing a limit order is that the order may never be filled. For example, a hot stock piques your interest when it’s selling for $10, so you decide to place a limit order to buy the stock at $10.50. By the time you call your broker or input the order into your trading system, the price already has moved above $10.50 and never drops back to that level – thus, your order won’t be filled. On the good side, if the stock is so hot that its price skyrockets to $75, you also won’t be stuck as the owner of the stock after purchasing near the $75 high. That high will likely be a temporary top that quickly drops back to reality, which would force you to sell the stock at a significant loss at some point in the future.
You may also consider placing your order as a stop order, which means that whenever the stock reaches a price that you specify, it automatically becomes a market order. Investors who buy using a stop order usually do so to limit potential losses or protect a profit. Buy stop orders are always entered at a stop price that is above the current market price.
When placing a sell stop order, you do so to avoid further losses or to protect a profit that exists in case the stock continues on a downward trend. The sell stop price is always placed below the current market price. For example, if a stock you bought for $10 is now selling for $25, you can decide to protect most of that profit by placing a sell stop order that specifies that stock be sold when the market price falls to $20, thus guaranteeing a $10 gain.
You don’t have to watch the stock market every second; instead, when the market price drops to $20, your stop order automatically switches to a market order and is executed.
The big disadvantage of a stop order is that if for some reason the stock market gets a shock during the news day that affects all stocks, it can temporarily send prices lower, activating your stop price. If it turns out that the downturn is merely a short‐term fluctuation and not an indication that the stock you hold is a bad choice or that you risk losing your profit, your stock may sell before you ever have time to react.
❯❯ Check with the brokers you’re planning to use to ensure that they accept stop orders.
❯❯ Find out what your brokers charge for stop orders.
❯❯ Review how your broker’s stop orders work, so you don’t run into surprises.
After all, you don’t want to execute a stop order and end up selling a stock that you didn’t intend to sell or at a price you find unacceptable.
You can protect yourself from any buying or selling surprises by placing a stop‐limit order. This type of order combines the features of both a stop order and a limit order. When your stop price is reached, the stop order becomes a limit order rather than a market order.
A stop‐limit order gives you the most control over the price at which you will trade your stock. You can avoid a purchase or sale of your stock at a price that differs significantly from what you intend. But you do risk the possibility that the stop‐limit order may never be executed, which can happen in fast‐moving markets where prices fluctuate wildly.
For example, you may find that deploying stop‐limit orders is particularly dangerous to your portfolio, especially when bad news breaks about a stock you’re holding and its price drops rapidly. Although you have a stop‐limit order in place, and the stop price is met, the movement in the market may happen so rapidly that the price limit you set is missed. In this case, the limit side of the order actually prevents the sale of the stock, and you risk riding it all the way down until you change your order. For example, say you purchased a stock at $8 near its peak. On the day the company’s CEO and CFO were fired, the stock dropped to $4.05. You may have had a stop‐limit order in place to sell at $5, but on the day of the firing, the price dropped so rapidly after the company announced the firing that your stop‐limit order could not be filled at your limit price.
You can avoid having to replace an order time and again by using a good‐’til‐canceled (GTC) order. GTC orders are placed at a limit or stop price and last until the order actually is executed or you decide to cancel it. A GTC order won’t be executed until the limit price is reached, regardless of how many days or weeks it takes.
You can choose to use this type of order whenever you want to set a limit price that differs significantly from the current market price. Many brokerage firms limit how much time a GTC order can remain in place, and most of them charge more for executing this type of order.
Less commonly used order methods include contingent, all‐or‐none, and fill‐or‐kill orders. Contingent orders are placed on the contingency that another one of your stock holdings is sold before the order is placed. An all‐or‐none order specifies that all the shares of a stock be bought according to the terms indicated or that none of the stock should be purchased. A fill‐or‐kill order must be filled immediately upon placement or be killed.
Chapter 3
Going for Broke(r): Discovering Brokerage Options
IN THIS CHAPTER
❯❯ Discovering broker types
❯❯ Finding out about broker service options
❯❯ Sorting through different types of brokerage accounts
❯❯ Deciphering trading rules
As an individual, you can’t trade stocks – or bonds, or options, or futures – unless you have a broker or are a broker yourself. That doesn’t mean, however,