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With the proliferation of digital technology and the internet, many investors are opting to buy and sell stocks for themselves online instead of paying advisors large commissions to execute trades. However, before you can start buying and selling stocks, it's important to understand the different types of orders and when they are appropriate.
In this article, we'll cover the basic types of stock orders and how they complement your investing style.
Market Order vs. Limit Order
The two major types of orders that every investor should know are the market order and the limit order.
Market Orders
A market order is the most basic type of trade. It is an order to buy or sell immediately at the current price. Typically, if you are going to buy a stock, then you will pay a price at or near the posted ask. If you are going to sell a stock, you will receive a price at or near the posted bid.
One important thing to remember is that the last traded price is not necessarily the price at which the market order will be executed. In fast-moving and volatile markets, the price at which you actually execute (or fill) the trade can deviate from the last traded price. The price will remain the same only when the bid/ask price is exactly at the last traded price.
Market orders do not guarantee a price, but they do guarantee the order's immediate execution.
Market orders are popular among individual investors who want to buy or sell a stock without delay. The advantage of using market orders is that you are guaranteed to get the trade filled; in fact, it will be executed as soon as possible. Although the investor doesn't know the exact price at which the stock will be bought or sold, market orders on stocks that trade over tens of thousands of shares per day will likely be executed close to the bid/ask prices.
Limit Orders
A limit order, sometimes referred to as a pending order, allows investors to buy and sell securities at a certain price in the future. This type of order is used to execute a trade if the price reaches the pre-defined level; the order will not be filled if the price does not reach this level. In effect, a limit order sets the maximum or minimum price at which you are willing to buy or sell.
For example, if you wanted to buy a stock at $10, you could enter a limit order for this amount. This means that you would not pay one cent over $10 for that particular stock. However, it is still possible that you could buy it for less than the $10 per share specified in the order.
There are four types of limit orders:
Market and Limit Order Costs
When deciding between a market or limit order, investors should be aware of the added costs. Typically, the commissions are cheaper for market orders than for limit orders. The difference in commission can be anywhere from a couple of dollars to more than $10. For example, a $10 commission on a market order can be boosted up to $15 when you place a limit restriction on it. When you place a limit order, make sure it's worthwhile.
Let's say your broker charges $7 for a market order and $12 for a limit order. Stock XYZ is presently trading at $50 per share and you want to buy it at $49.90. By placing a market order to buy 10 shares, you pay $500 (10 shares x $50 per share) + $7 commission, which is a total of $507. By placing a limit order for 10 shares at $49.90, you would pay $499 + $12 commissions, which is a total of $511.
Even though you save a little from buying the stock at a lower price (10 shares x $0.10 = $1), you will lose it in the added costs for the order ($5), a difference of $4. Furthermore, in the case of the limit order, it is possible that the stock doesn't fall to $49.90 or less. Thus, if it continues to rise, you may lose the opportunity to buy.
Additional Stock Order Types
Now that we've explained the two main orders, here's a list of some added restrictions and special instructions that many different brokerages allow on their orders:
Stop-Loss Order
A stop-loss order is also referred to as a stopped market, on-stop buy, or on-stop sell, this is one of the most useful orders. This order is different because, unlike the limit and market orders, which are active as soon as they are entered, this order remains dormant until a certain price is passed, at which time it is activated as a market order.
For instance, if a stop-loss sell order were placed on the XYZ shares at $45 per share, the order would be inactive until the price reached or dropped below $45. The order would then be transformed into a market order, and the shares would be sold at the best available price. You should consider using this type of order if you don't have time to watch the market continually but need protection from a large downside move. A good time to use a stop order is before you leave on vacation.
Stop-Limit Order
These are similar to stop-loss orders, but as their name states, there is a limit on the price at which they will execute. There are two prices specified in a stop-limit order: the stop price, which will convert the order to a sell order, and the limit price. Instead of the order becoming a market order to sell, the sell order becomes a limit order that will only execute at the limit price or better. This can mitigate a potential problem with stop-loss orders, which can be triggered during a flash crash when prices plummet but subsequently recover.
All or None (AON)
This type of order is especially important for those who buy penny stocks. An all-or-none order ensures that you get either the entire quantity of stock you requested or none at all. This is typically problematic when a stock is very illiquid or a limit is placed on the order. For example, if you put in an order to buy 2,000 shares of XYZ but only 1,000 are being sold, an all-or-none restriction means your order will not be filled until there are at least 2,000 shares available at your preferred price. If you don't place an all-or-none restriction, your 2,000 share order would be partially filled for 1,000 shares.
Immediate or Cancel (IOC)
An IOC order mandates that whatever amount of an order that can be executed in the market (or at a limit) in a very short time span, often just a few seconds or less, be filled and then the rest of the order canceled. If no shares are traded in that "immediate" interval, then the order is canceled completely.
Fill or Kill (FOK)
This type of order combines an AON order with an IOC specification; in other words, it mandates that the entire order size be traded and in a very short time period, often a few seconds or less. If neither condition is met, the order is canceled.
Good 'Til Canceled (GTC)
This is a time restriction that you can place on different orders. A good-til-canceled order will remain active until you decide to cancel it. Brokerages will typically limit the maximum time you can keep an order open (or active) to 90 days.
Day
If you don't specify a time frame of expiry through the GTC instruction, then the order will typically be set as a day order. This means that after the end of the trading day, the order will expire. If it isn't transacted (filled) then you will have to re-enter it the following trading day.
Take Profit
A take profit order (sometimes called a profit target) is intended to close out the trade at a profit once it has reached a certain level. Execution of a take profit order closes the position. This type of order is always connected to an open position of a pending order.
Not all brokerages or online trading platforms allow for all of these types of orders. Check with your broker if you do not have access to a particular order type that you wish to use.
The Bottom Line
Knowing the difference between a limit and a market order is fundamental to individual investing. There are times where one or the other will be more appropriate, and the order type is also influenced by your investment approach.
A long-term investor is more likely to go with a market order because it is cheaper and the investment decision is based on fundamentals that will play out over months and years, so the current market price is less of an issue. A trader, however, is looking to act on a shorter-term trend in the charts and, therefore, is much more conscious of the market price paid; in which case, a limit order to buy in with a stop-loss order to sell is usually the bare minimum for setting up a trade.
By knowing what each order does and how each one might affect your trading, you can identify which order suits your investment needs, saves you time, reduces your risk, and, most importantly, saves you money.
What Is an Order?
An order consists of instructions to a broker or brokerage firm to purchase or sell a security on an investor's behalf. An order is the fundamental trading unit of a securities market. Orders are typically placed over the phone or online through a trading platform, although orders may increasingly be placed through automated trading systems and algorithms. When an order is placed, it follows a process of order execution.
Orders broadly fall into different categories. This allows investors to place restrictions on their orders affecting the price and time at which the order can be executed. These conditional order instructions can dictate factors such as a particular price level (limit) at which the order must be executed, for how long the order can remain in force, or whether an order is triggered or canceled based on another order.
Understanding Orders
Investors utilize a broker to buy or sell an asset using an order type of their choosing. When an investor has decided to buy or sell an asset, they initiate an order. The order provides the broker with instructions on how to proceed.
Orders are used to buy and sell stocks, currencies, futures, commodities, options, bonds, and other assets.
Generally, exchanges trade securities through a bid/ask process. This means that to sell, there must be a buyer willing to pay the selling price. To buy there must be a seller willing to sell at the buyer's price. Unless a buyer and seller come together at the same price, no transaction occurs.
The bid is the highest advertised price someone will pay for an asset, and the ask is the lowest advertised price at which someone is willing to sell an asset. The bid and ask are constantly changing, as each bid and offer represents an order. As orders are filled, these levels will change. For example, if there is a bid at 25.25 and another at 25.26 when all the orders at 25.26 have been filled, the next highest bid is 25.25.
This bid/ask process is important to keep in mind when placing an order because the type of order selected will impact the price at which the trade is filled, when it will be filled, or whether it will be filled at all.
Order Types
On most markets, orders are accepted from both individual and institutional investors. Most individuals trade through broker-dealers, which require them to place one of many order types when making a trade. Markets facilitate different order types that provide for some investing discretion when planning a trade.
Order types can greatly affect the results of a trade. When trying to buy, for example, placing a buy limit at a lower price than what the asset is currently trading at may give the trader a better price if the asset drops in value (compared to buying now). But putting it too low may mean the price never reaches the limit order, and the trader may miss out if the price moves higher.
Market Order
A market order instructs the brokerage to complete the order at the best available price. Market orders are generally always executed unless there is no trading liquidity.
Limit Order
A limit order is an order to buy or sell a stock at a specific price or better. Limit orders ensure that a buyer pays only a specific price to purchase a security. Limit orders can remain in effect until they are executed, expire, or are canceled.
Limit Sell Order
A limit sell order instructs the broker to sell the asset at a price that is above the current price. For long positions, this order type is used to take profits when the price has moved higher after buying.
Stop Order
A stop order instructs the brokerage to sell if an asset reaches a specified price below the current price. A stop order can be a market order, meaning it takes any price when triggered, or it can be a stop-limit order wherein it can only execute within a certain price range (limit) after being triggered.
Buy Stop Order
A buy stop order instructs the broker to buy an asset when it reaches a specified price above the current price.
Day Order
A day order specifies the timeframe of the order rather than the type of order. A day order must be executed during the same trading day that the order is placed.
GTC Order
A good-'til-canceled (GTC) order also indicates the timeframe in which the trade must be executed. This type of order remains in effect until it is filled or canceled.
If an order is not a day order or a good-'til-canceled order, the trader typically sets an expiry for the order.
Immediate-or-Cancel Order
Immediate-or-cancel (IOC) means that the order only remains active for a very short period of time. This could be as short as several seconds. If the order is not executed in that time, it expires.
All-or-None Order
An all-or-none (AON) order specifies that the entire size of the order be filled. Partial fills will not be accepted. If the whole order is not filled, it is not completed at all.
Fill-or-Kill Order
A fill-or-kill (FOK) order must be completed immediately and completely or not at all. It combines an all-or-none order with an immediate-or-cancel order.
One order type isn't better or worse than another. Each order type serves a distinct purpose. The correct order to use depends on the trader's goals and tolerance for risk.
Example of Using an Order for a Stock Trade
When buying a stock, a trader should consider how they will get in and how they will get out at both a profit and loss. This means there are potentially three orders they can place at the outset of a trade: one to get in, a second to control risk if the price doesn't move as expected (referred to as a stop-loss), and another to eventually trade profit if the price does move in the expected direction (called a profit target).
A trader or investor doesn't need to place their exit orders at the same time they enter a trade, but they still should be aware of how they will get out (whether with a profit or loss) and what order types they will use to do it.
Assume a trader wants to buy a stock. Here is one possible configuration they could use for placing their orders to enter the trade as well as control risk and take profit.
They watch a technical indicator for a trade signal and then place a market order to buy the stock at $124.15. The order fills at $124.17. The difference between the market order price and the fill price is called slippage.
Image by Sabrina Jiang © Investopedia 2020
They decide that they don't want to risk more than 7% on the stock, so they place a sell stop order 7% below their entry at $115.48. This is the loss control, or stop-loss.
Based on their analysis, they believe they can expect a 21% profit from the trade, which means they expect to make three times their risk. That's a favorable risk/reward ratio. Therefore, they place a sell limit order 21% above their entry price at $150.25. This is their profit target.
One of the sell orders will be reached first, closing out the trade. In this case, if the price reaches the sell limit first, it results in a 21% profit for the trader.
A limit order sets the highest price at which an investor will buy an asset and the lowest price at which they are willing to sell. This is intended to maximize profits and minimize losses. A market order is more open-ended and instructs the broker to complete the trade at the best available price.
A batch order is not the same as a market order, but it is made up of multiple market orders. These orders are sent between the close of one day's session and the start of the next. A batch order is placed by a brokerage, combining multiple orders for the same stock as if they were one single transaction. This type of order is only executed for orders placed between trading sessions and happens at the opening of the market for the day.
Orders allow traders to enter or exit a trade at a specific price and during a set timeframe. Trading orders are used to maximize profits and limit losses. They can also allow traders to take advantage of sudden or unexpected price movements.
The Bottom Line
An order is an instruction given to a broker to buy or sell an asset on behalf of a trader. The different types of orders allow investors to specify the price at which they buy or sell, when the trade occurs, and whether it will be fulfilled or canceled if certain conditions aren't met.
Traders place orders depending on how they predict the asset will move, what level of profit they want to make, and how quickly they want the trade executed. A trader can place multiple types of orders at once to protect their profit and minimize the risk of loss on a trade.
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