If you are new to trading, you may have been told to only stick to market orders when purchasing or selling stocks. When doing this, you may also have noticed that the price that you purchased or sold your security may have differed slightly from the number that was shown to you on the trade ticket.
This may be confusing to new investors, as the market is as dynamic as it is abstract, changing at every second. These split seconds can make all the difference when executing your trades, that is why special orders can be placed to specify at what amount yo want to trade at to control and ensure that your security is purchased at your specific price, or maybe better! However, instead of waiting in a long line in person, trades are performed on the Electronic Communication Network (ECN), allowing a buyer and a seller to be matched without either of them having to get up from their seat. Keep in mind that the laws of supply and demand still apply and that sales are always performed on a first-come, first-serve basis.
When people imagine trading in the stock market, they usually imagine a market order. This order type is usually easier to understand which is why it is often recommended for beginners.
When placing a market order, you are buying or selling a security at that instant, without limiting yourself to a specific price or price range. This allows your trade to be executed faster, as the ECN is not limited by price when matching you to a buyer or seller. It is because of this that your trades may be off by a few cents or dollars, depending on the volatility of the security.
This may be frustrating to those who may only have a certain amount of cash in their brokerage account and want to make sure that they don't spend more than they have available to trade with. This can also be disappointing to the meticulous trader, who cares about every cent, when their sale is executed at a value less than expected.
Placing limit orders is one way to ensure that you don't exceed your trading budget or undersell your security.
When buying with a limit order, you are telling the ECN that you want to purchase a security from someone AT or BELOW a specific price, allowing you to prevent paying more for a security than desired. This also means that if the price of your desired security drops even lower than your desired price, then your trade will still be executed, given that is it still within the time limit that you have set.
Similarly, when selling with a limit order, you are telling the ECN that you want to sell your security to someone AT or ABOVE your desired price, allowing you to make sure that you don't lose the value of your trade if the price fluctuates more than expected.
If the price goes even higher, then your security can still be sold at the higher rate given that it is within the time limit that you have set.
A stop order, simply put, is unique from limit and market orders as your order will not be seen by the ECN until your specified price of the security that you are trading has been met. Once the security meets your set price or better, your order will turn in to a market order and the ECN will look for a seller or buyer to execute the trade.
Setting a stop order will allow you to time when to enter or exit a position in the market, but once it turns in to a market order, it will be subject to variations in price, meaning that you may end up buying or selling at a price different than expected.
In some cases, stop orders are used to leave a position if it falls at a concerning rate in order to prevent losing too much on your investment, often called "stop-loss" orders.
Stop orders can also be used to ride any upward momentum a security may have and catching some potential growth on your investment. Keep in mind that the market is unpredictable and that one must due their due diligence before deciding to buy or sell securities.
Similar to how a stop order turns in to a market order when the desired price is met by the market, it could also turn in to a limit order, forming a combination stop-limit order.
Once the specified price is reached, a security can be purchased or sold with the limitations of using a limit order, allowing you to prevent paying more for, or underselling a security.
When a limit is placed on a stop order for a sale, you can queue a trade when a stock's price starts to dip and prevent the trade form being executed if it goes too low. When used on a purchase, an order will be submitted when a stock's price goes up and will prevent the trade from being executed if it gets too high.
Once you decide which type of order you want to place for a security, you will then be prompted to set a time frame for your order to be executed. There are a variety of ways to tell your brokerage how long you're willing to keep your order open for. The main ones include:
Day Only: if the conditions of the order are met before the end of the current trading day within trading hours (9:30am to 4:00pm EST), the order will be executed. If the order is placed outside of trading hours, then it will only be valid for the next trading day.
Fill or Kill: if the conditions of your trade are met immediately and the order is able to be filled in its entirety, then the trade will be executed.
Immediate or Cancel: if the conditions of your trade are met immediately, and your order is still able to be partially filled, then your trade will be executed.
Good till Canceled: your order will be valid for a period of time that you specify. Usually these automatically expire after around 60 or 90 days (depending on your brokerage) to prevent forgotten orders from being accidentally executed. If your conditions are met by your specified date, then your trade will be executed.
As mentioned above, all orders placed are filled on a first-come first-serve basis. If you submit a sale for a stock that many others in the market are trying to get rid of, then it may take longer than an instant for the ECN to match you to a buyer.
When using a special order type, you are negotiating the terms of your trade. Similar to negotiations in non-abstract settings such as the market, the terms must be realistic in order for the opposing party to agree.
Sometimes, only part of your trade can be executed as there were not enough buyers or sellers with enough shares of a security to completely fill your order within your terms. For example, if you were to set a limit order for a purchase of two shares of Microsoft (MSFT) for $1, you are very unlikely to be matched with a seller for that price, and your order will not be filled. Let's say, in this hypothetical situation, that there was a seller out there willing to part with their MSFT shares, but was only willing to sell one share for $1, then your order will only be partially executed.
Disclaimer: This article is not financial advice and is intended only for educational purposes. Investments are not FDIC insured and carry risk. Please check with your brokerage for more information.