Beyond learning the lingo, It pays to comprehend the actions
Most investors and traders understand two or three of the most widely used types of buy or sell orders. These include market orders, GTC (Good-Till-Cancelled) and limit orders. But there are many other types. This article summarizes a range of orders, their purpose and how they work.
Most people place market orders for the majority of their trades. This is simply an order to buy or sell shares at the stock’s current market price, to be executed as soon as possible. This doesn’t mean you get the price reported online even in a real-time quotation system. By the time the order is placed — even only minutes later — the price might be higher or lower. You assume this risk when placing a market order, in exchange for the certainty of fast order execution. Another advantage is that this is the cheapest kind of order to place; many other order types are available only at a premium. Although the market order by itself is widely understood, it plays a key role related to other types of orders. Many orders serve as triggers based on a predetermined price. Once that occurs, those specialized orders become market orders and are executed as soon as possible.
This is any order that stays open awaiting conditions to trigger execution, until you cancel the order. Although your broker might limit the time a GTC will be left open, the important point to remember is that you’re responsible for cancelling it if conditions change. You can apply the GTC label to other types of orders, which leads to some interesting combinations. For example, you can specify execution price and keep the GTC label on the order or allow it to expire at the end of a single trading session. GTC improves flexibility and timing, especially if you’re concerned with a stock’s volatility and need to decide later whether to let an order expire or stay on the books.
Unlike the GTC, the day order stays open only during the current session. At the end of the session, the day order expires. You use this when you decide on execution but only if your price can be reached before the close. Knowing the day order will expire, you can then review conditions the following day before deciding what action, if any, to take. If you don’t want the order to expire, change it to a GTC order.
The limit order specifies the exact price of execution. The buy or sell will go through only if that price is reached. If it isn’t, the order won’t be placed. A variation on the limit order expands the fixed price; when a limit order is modified to “or better,” you’re instructing that the shares should be bought at or below the specified price, or sold at or above the specified price. The limit order doesn’t always go in at the exact price, and this is a fine point worth noting. The order instructs execution once the price has been reached; however, execution may occur above or below that level. A buy limit order requires execution at or below the limit price; a sell limit order requires execution at or above the limit price.
This order creates a price trigger to prevent unexpected losses because of sudden price changes in the stock. When you enter the order, it specifies a price level lower than the current market price. Once the stock price falls to that level, the stop-loss becomes a market order and is executed immediately. If the stock price remains above the stop-loss level, the order is never executed.
A variation on the stop loss order is the buy stop. This order tells your broker to execute a buy only when the price is higher than the current market price. Once the value moves to or above that price, the buy stop becomes a market order and is executed immediately. The purpose of this order is to ensure that you’re able to buy shares before a large rally takes place. Assuming the rise in price is the first step in a rally, you get shares early in the process by using the buy stop. If the price of shares never rises to your trigger price, the order is never executed. The value of this kind of order is that it takes advantage of upward-movement momentum. But this doesn’t guarantee that the price won’t reverse after the buy stop order is placed.
The opposite of the buy stop is the sell-stop order, also called a sell stop-loss order. This instructs the sale of shares below current market. The specified price is the trigger; once it’s met the sell-stop order becomes a market order, to be executed as soon as possible. The order cannot guarantee that the order price will be the final sale price. The specified price is only a trigger, so in a rapidly falling market, after the trigger occurs the actual order might go in at a different price.
Buy-Stop Limit Order
With this order, execution occurs at or below the specified price, but only after the stop price has also been reached. So it requires two steps before execution. As soon as the stop price is reached, this order reverts to a straight buy limit order, to be filled at or below the limit price. This type of order gives you control over when an order gets executed, as well as setting a maximum trigger price.
Sell-Stop Limit Order
The sell-stop limit order is the opposite of the buy-stop limit. Execution must take place at or above the specified price, but only after the stop price has also been reached. After the stop price is reached, this becomes a sell limit order and is executed at or above the limit price. This order lets you control when your sell order is executed and also lets you set the minimum execution price.
Buy to Cover Limit Order
This is a specialized type of order used to cover open short positions. It’s executed at a price below current market price. Used when you have shorted stock or options (including covered calls), this order sets up the minimum exit price, which is also a form of limit price. This protects profits on short positions when the price falls and automatically sets up a profit-taking close of the position.
Buy to Cover Stop
This is very much like the buy stop order, except that with the buy to cover version, it kicks in to exit a short position. The order is to buy to close short positions at a price that’s higher than current market value. It cuts your losses when the short stock price moves up instead of down. It reverts to a market order once the stop order price is reached or passed. As with most of these stop orders, the price isn’t guaranteed; the price works only as a trigger to revert to market order status and then execute the closing buy order.
The stop order can be expanded and made into a trailing stop. It’s like the stop-loss order, but instead of a set execution price, it’s expressed as a percentage of the market price. If the price falls by the percentage set in the trailing stop, the order automatically becomes a market order and is executed. If the stock price rises, additional gains are protected; the percentage required for automatic execution is continually revised to the new higher price. The advantage to trailing stops is that the order protects your profits, including adjustment to the upside as prices rise. Once a decline occurs, the sale takes place immediately. The disadvantage is that, because it’s automatic, you cannot control the timing of the sale — unless you cancel the trailing stop before the decline in price occurs. (Editor’s note: Regarding this order and others, we’re not advocating investors use the orders described in this article. Long-term investors often are well-served by the most common types of buy and sell orders.)
All or None
This is a condition placed on any order requiring that the entire order has to be filled — or none of it can be filled. This becomes important in cases in which the stock you’re buying or selling has a low trading volume. In that case, you may want to execute an AON order so that you don’t have to suffer through execution of only a few shares at a time.
Fill or Kill
This is a condition attached to an order to execute it immediately or to kill the order. It’s also called “immediate or cancel.” When you’re transacting a large number of shares, you might want the entire number of shares bought or sold right away. This isn’t a commonly used trade, but it does have a strategic value when a lot of shares are on the table, especially if execution is likely to change the overall market value of outstanding shares.
The Lingo for Long and Short Orders
An important distinction has to be made not only between buy or sell but also in whether you’re dealing with long or short transactions. Most stockholders buy shares with an opening order and then close those positions with a sell. This sequence is buy-hold-sell and is widely understood. If you enter short positions, however, the sequence of events and terminology are reversed. The sequence is sell-hold-buy. Orders on each end are flipped as well. The opening transaction is a sell to open and the closing transaction is a buy to close.
Different Names Still Work
Although some brokers use different names for the orders listed above, the important point is to understand the steps and actions that each type of order produces.
Michael C. Thomsett was the author of more than 70 published books. Among these are Getting Started in Stock Investing and Trading (Wiley), which includes practical suggestions for picking stocks based on fundamental analysis. He is also the author of Annual Reports 101 (Amacom Books), Getting Started in Fundamental Analysis (Wiley) and Investment and Securities Dictionary (McFarland).
This article was originally published in the March 2011 issue of BetterInvesting Magazine.