There are several stock order types to choose from when you buy your first stock or ETF. Since each type of order has its advantages and disadvantages, knowing how each one works is something every investor needs to learn.
Anytime you buy or sell a stock or ETF a trade happens. Each time a trade occurs two things happen. A buyer (bid price) and seller (ask price) must both place an order and if the buyer and seller agree on the price a trade happens between the two parties.
That’s the simple version.
In reality, this happens millions of times every day the market is open. And it doesn’t guarantee your order will go through. When you find an online broker, deposit money, and place your first order to buy a stock, there has to be another investor willing to sell their shares or you’re out of luck.
The order type you use will eventually determine the price you pay, time length of the trade, and if your money is protected. The last thing you want is to place the wrong order and risk losing money. The best way to prevent that is to explain how each order works.
Stock Order Types Explained
A market order is an order placed to buy or sell a stock at the next best available price without any restrictions. You use a market order when the execution of the order is far more important than the price you pay for the stock. There are two types of market orders:
- Buy Market Order – is an order to buy a stock at the next best available market price. The downside – any major upswing in the price of the stock before the order is placed you may end up paying more than you wanted for the stock.
- Sell Market Order – is an order to sell a stock at the next best available market price. The downside – any major downswing in the price of the stock before the order is placed you may end up selling the stock for less than you wanted.
Learn more about a market order.
A limit order is an order placed to buy or sell a stock at a specific price or better. This type of order protects you from those sudden swings in stock price. It also means you will only buy or sell the stock if it reaches the price you want. If you’re just starting out, limit orders are a great stock order type to use. The added price protection offers a little piece of mind. But more important it forces you to put a value on what you’re willing to pay regardless of the daily fluctuations in a stock’s price. Just like the market order there are two types of limit orders:
- Buy Limit Order – is an order to buy a stock at a specific price or lower. Basically you’re telling the broker the highest price you’re willing to pay for a stock and not a penny more. The downside to this is the possibility that you never buy the stock if the price never drops to where you’re willing to pay.
- Sell Limit Order – is an order to sell a stock at a specific price or higher. Basically you’re telling the broker the lowest price you’re willing to pay for a stock and not a penny less. The downside to this is the possibility that you never sell the stock if the price never rises to where you’re willing to pay.
Learn more about a limit order.
A stop order is an order that eventually becomes a market order once an activation (or stop) price is reached or passed. A stop order helps limit a potential loss or can be used to lock in profits. It has the same downsides as a market order once the activation price is hit. There are two types of stop orders:
- Buy Stop Order – is an order that requires you to set an activation price above the current ask price. When the price of the stock reaches that activation price a buy market order is placed immediately. Buy stop orders are used when you short sell stock to protect from a potential loss if the stock price rises.
- Sell Stop Order – is an order that requires you to set an activation price below the current bid price. When the price of the stock reaches that activation price a sell market order is placed immediately. Sell stop orders are used to limit a potential loss if a stock price falls.
Learn more about a stop order.
Stop Limit Order
A stop limit order combines a stop order with a limit order. An activation price and a limit price are placed with a stop limit order. The activation price and limit price can be the same or you can choose a different limit price. When the activation (or stop) price of your order is reached a limit order is placed. The downside is the same as a limit order with the possibility that the order doesn’t go through due to the limit price never being hit.
Trailing Stop Order
A trailing stop order is an order entered with an activation (or stop) parameter that creates a moving or “trailing” activation price. What that means is – as the stock price moves the activation price for your order also moves. For example, if you buy a stock at $40 and you put a sell trailing stop order at $4, if the stock hits $36 the trailing stop order is activated and the stock is sold at the market price. Now, if the stock rises in value to $45 the trailing stop order will then rise to $41. If the price of the stock goes up a new trailing activation price is set, if the price goes down the activation price remains the same. There are two ways to set an activation parameter with a trailing stop order:
- As a Point Value ($) – which is a fixed dollar value that trails the price of the stock. The dollar value doesn’t change as the price of the stock rises (for trailing stop sells) or lowers (for trailing stop buys).
- As a Percentage (%) – which is a proportionate dollar value to any new high price in the stock (for sell trailing stop orders) or any new low price (for buy trailing stop orders). What this means is the dollar value will increase slightly but the percentage will stay the same.
Learn more about a trailing stop order.
Short selling is a less common trade that allows you to potentially profit from a decline in the price of a stock. With short selling you borrow stock for a fee and sell it at the current price with the hope to buy it back at a lower price. The difference between the price you sell the stock at and the lower price you buy the stock back at is your profit. If the price of the stock goes up you lose money. Short selling should only be used by experienced investors.
Learn more about short selling stock.
What Is Time In Force?
When you place an order you’ll have to decide how long you want it to last. Time in force is simply a term used to describe the duration of an order before it’s canceled. Some order types only have one option while others may have several choices. The more common of the these options are:
- Day – indicates that you want the order to be canceled at the end of the regular trading day or 4 PM EST. It’s the only option for market orders. For other orders, if you don’t specify a time in force, the order will cancel at the market close.
- Good Till Canceled (GTC) – lasts until it’s executed or canceled. You can also enter a specific date you want the order to be canceled. GTC orders will occur during the regular trading day unless you add a plus extended hours.
- Plus Extended Hours – is an extra option available for some of the order types that allow the trade to occur outside of the regular trading day. The extended trading hours last from 8 AM EST – 8 PM EST. There are several variations of this time in force option. It should only be used by experienced investors who understand the risks of after hours trading.
The Recommended Trade
There are advantages and disadvantages to all the stock order types. But if you’re just starting out, stick to limit orders when you want to buy or sell a stock or ETF. There are times where a stop order or trailing stop order comes in handy. But you’re better off keeping things simple early on.