Now that you are becoming a genius in financial assets your next step is learning how to place trades. This episode will stick with stocks since it is the most commonly known amongst all asset classes. There are various types of trades and increasing level of trading sophistication. However as an individual investor you just need to understand and use only a few types of trades.
Let’s start with Market Orders which are the simplest of trades. A market order is simply a trade to buy or sell stock at the market price. Market orders are guaranteed execution because there are no restrictions; one simply buys or sells at market price. One caveat, if you have access to real time quotes you are very likely to have your trade executed at the quote you see on your screen. However, since market orders have no restrictions it is possible your trade can be executed at a slightly higher price and vice versa.
Next type of trades is called Limit Orders. Limit orders are trades to buy or sell a stock at a specified price or better. Typically these orders may cost more than market orders because the restriction makes it tougher for a broker to execute. For example, one places a buy limit on stock XYZ at $100. In order for this trade to execute the market price of the stock must be $100 or lower. An investor receives the benefit of limiting his cost at no greater than $100 per share. Wow it is just that simple, really nothing too complicated here.
Similar to limit orders, Stop Orders are another type of trade an investor can use. This type of trade has similar features to a limit order except there is no protection of price execution. Allow me to make explain this in simpler terms. If one places a sell stop order for stock XYZ at $100, the trade will only get executed at a price after XYZ stock hits $100 per share. The stop order becomes a market order once the stop price has been reached. It is possible your stop order execution price can be below, at or above $100. If you want to learn more about the difference between limit and stop orders and their advantages and disadvantages just click the link.
If are you still awake and not bored to death the genius in you is theorizing about the existence of stop limit orders. The answer to your theory is yes stop limit orders do exist. Stop Limit Orders combines the features of both stop and limit orders. When one places a stop limit order the trade starts of as a stop order and then once the market price of the stock hit the stop price, the trade gets converted to a limit order. For example, one places a stop limit order to sell 100 shares of XYZ at 100 stop price and limit sell order at 99.99. In order for this trade to execute, the market price of XYZ must first hit $100 and then XYZ must trade at $99.99 or below. This type of order is typically used to protect profits. I am not lying or messing with you, it is really that simple.
The final type of stock order I will discuss is Trailing Sell Stop orders which are my favorite and a great innovation of stock trades. This type of order has all the features of sell stop orders except the stop price rolls or trails the highest intraday price of a stock based on the spread between the two prices. I know scary but don’t piss your pants this is very simple and once you understand will always use this type of order to lock or make greater profits. What do I mean by spread? The spread is simply stop price you set in this type of trade it is typically a percentage of the market price. For example, I place a trailing sell stop order to sell 100 shares of XYZ at 20% below the current market price. The duration of this trade is usually 90 days and is called Good Til Cancel. This order will be setup by the broker in absolute values, 80% (100% - 20%) of stop price of $100 is $80. This trade will only execute if the stock hits $80 within the next 90 days. However, I have the set stop price to be a percentage of the highest intraday price of XYZ. It is possible my stop price can rise with the market price of XYZ but stop price can never go lower than $80.
Ahhhh I can see your brain lighting up thinking of locking in profits but with the possibility of killer profits. Let’s continue, a week later XYZ rises to $110. My new stop price is now $88 dollars. Wow you are thinking this is magic and too good to be true. No, this is for real; you can have your cake and eat it too. Your stop order has increased by 10% and will be protected at the new stop price of $88. You are thinking what happens when the market price goes below $110 does your stop price gets lowered? No, you are protected at $88 but your spread has been reduced. Let’s assume two weeks later XYZ falls to $90 per share. Your stop price will still be $88 per share.
Don’t believe me ask your broker. I rarely make any recommendations but I do highly recommend this type of trade when selling stock to protect profits.
There are host of all other types of orders such as Fill or Kill, All or None, Trailing Stop Limit Orders which you can look up and learn about their advantages and disadvantages. If you want to learn more please visit these websites which are the sources I have been using for the Naked Investing series.
http://www.sec.gov/index.htm
http://www.investopedia.com/#axzz2LIW5HCat
http://www.wikipedia.org/
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