Investing in the stock market offers us several order types to make our life easier. In this post, we are going to review them, so readers can understand how each one of them works.
Market order
This is the most intuitive order. You launch a buying or selling order to the market, and it automatically executes it at the current price.
Although the concept is quite intuitive, the reality can be treacherous because the market moves very fast.
It can happen that you see a price on your computer screen; and in the few seconds that you need to click the button and launch the order, it changes. It can change in your favour or against your interests; but as Murphy’s law works very well, it will usually go against you.
A small variation in the price multiplied by the number of shares you are trading can mean a significant amount of money.
Thus, this order is usually only used when the trader needs to execute the order as fast as possible, but there is an important loss of control.
Limit order
This order solves the problem mentioned above. With this one, you can set the worst price that you would accept (the highest, if buying, and the lowest, if selling); so if the market moves against you, the order will not be executed.
The issue here is that sometimes you launch an order, and it never get executed. This may happen even if you set the same price that you are seeing on your screen because the screen usually shows the last trade price, which does not assure you that there will be a counterpart now or in the next future.
Buy or sell stop
When you decide to use a buy stop or sell stop order, you are giving the order to trade only when the stop is reached.
For example, if you see that the price is close to confirming a head-and-shoulders figure, you can set the order at the price that would confirm the figure and leave your computer peacefully, knowing that if the movement is confirmed, your order will be launched.
The bad surprise with this type of order is that the order is launched as soon as the price touches a certain level; but in the seconds your order finally arrives to the market, the price could have changed.
For example, if you set a stop-loss at 45, once the order executes, the price could already be at 43.
The worst-case scenarios are usually related to gaps. You have the order at 45, the market opens with a gap at 40, the order executes at 40, and at the end of the day, the price recovers at 45, but your shares are already sold.
Variations of this order are the stop-loss and take-profit orders.
Stop limit order
This order combines the two previous types of orders. The idea is that the order will only be launched if the price touches your stop, but it will only execute if you get the price of the limit or better.
If we take the previous example with the order at 45 and the gap at 40, it would mean that the order would have not been executed in the gap because that is a worse price than 45; and then it could have been executed at 45 after the recovery. However, such a recover does not always happen, and the price can continue falling while your order is waiting for an execution.
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