When it comes to buying and selling securities most people assume that there is really just one way to do so. You can click “buy” or click “sell”, or you can call your investment advisor and tell them to “buy” or “sell”, and that is the end of the story. While it is true that the vast majority of security transactions are executed in this manner, there are actually many other options available, which may be more suitable, depending on your specific goals and investment strategy.
Before we get into the details of alternative ways to trade securities, let’s take a moment to make sure we are clear on how most people trade, which is called a “Market Order”.
The most basic way to buy or sell a security is through a Market Order. When you enter a Market Order, you are basically indicating that you want to buy or sell the security immediately and that you are willing to pay or receive whatever the market price for the security happens to be at that moment. A Market Order essentially guarantees that your trade will be executed quickly. However, it does not make any guarantee as to the price at which the trade will execute. In general, Market Orders are used when it is more important that you buy or sell a security immediately, then it is to know ahead of time that you will buy or sell only at a specific predetermined price or better.
When trading popular, well know securities, where there are always lots of willing buyers and sellers, Market Orders are usually executed somewhere near the current quoted price. However, when buying or selling a more thinly traded security, where there are relatively few buyers or sellers for the security, there can be a significant difference between the current quoted price you see, and the price you actually end-up receiving when entering and executing the order.
Here is an example of how a Market Order can work against you.
Let’s say XYZ company stock currently trades for $10 per share. You believe the price of the stock is likely to go up in the future and place a market order to buy 100 shares. However, in the time it takes for your order to process and execute, the stock’s price increases to $11 per share. In this scenario, you will end up buying 100 shares at $11 per share, spending $1,100, or 10% more, than if the trade had executed at $10 per share.
In order to avoid the above problem, there are several alternate options available to an investor when trading a security. Below, we will discuss just a few of the more common alternatives to simply placing a Market Order.
If you want to buy or sell a security, but only if you are guaranteed a certain price (or better), then instead of a Market Order, you would want to use a “Limit Order”. A buy Limit Order will only be executed at your stated limit buy price or lower. A sell Limit Order will only be executed at your stated limit sale price or higher.
Investors often use Limit Orders, instead of Market Orders, when they have a security position they would like to buy or sell, but only if and when they can do so at a lower or higher price than the price at which the security is currently trading. With a Limit buy or sell, the investor does not have to sit watching the movement of the stock price all day to wait for the “right” price. Instead, they can set the limit price ahead of time, and rest assured that the trade will happen automatically if and when their limit price is reached and securities are available to be bought or sold at that desired price or better. In addition, with a Limit Order, the investor does not have to worry that the price of the security will move against them in the time it takes to actually execute the order, as it can with Market Orders. Of course, the downside of using a Limit Order instead of a Market Order, is that it is quite possible that the security never reaches the limit price, and thus, never gets bought or sold.
Here is an example of how a buy Limit Order works.
Let’s once again assume XYZ company is trading at $10 per share. You are interested in buying 100 shares of XYZ stock, but only if the price drops to $8 or less. Instead of sitting in front of your computer all day, endlessly checking stock prices to see if the price has dropped, you can instead set a buy Limit Order. If this scenario, you could set a limit order to buy 100 shares of Stock XYZ at a limit price of $8. Under these instructions, if the price of XYZ stock ever goes to $8 or below, there will be an automatic attempt to buy the shares. However, in the event that the stock hits $8, but then goes right back up before your trade has executed, no trade will take place on your behalf.
If you don’t like the loss of control that comes with a Market Order, but also don’t like the inflexibility of the pure Limit Order, then there is another option, the “Stop Order”. A Stop Order is basically a combination of a Market Order and a Limit Order. A Stop Loss Order is an order to sell a security once it hits a certain level on the downside. A Buy Stop Order is an order to buy a security once it hits a certain level on the upside.
As you can see, a Stop Order is like a Limit Order in that it does not trigger until a certain price is reached. However, unlike a Limit Order, there is no guarantee as to the final price of the buy or sale. Once the limit price is reached, the order then becomes a Market Order, and will be executed at the next available price, whatever it may be. In general, Stop Orders are used by investors who know they are interested in buying or selling a security above or below the current price, but are not so concerned as to the exact final execution price.
Here is an example of how a buy Stop Order works.
XYZ company is trading at $10 per share. You are interested in buying 100 shares of XYZ stock, but only if the price drops. In this scenario, you could set a Stop Order to buy 100 shares of Stock XYZ at a stop price of $8. Under these instructions, if the price of XYZ stock ever goes to $8 or below, the Stop Order automatically becomes a Market Order, and your purchase will happen at the next avaible price. The difference between a Stop Order and a Limit Order, is that you could still end-up paying more (or less) than $8 for each of your shares.
All or None
“All or None” is a designation that can be added to a buy or sell order which indicates that the investor wishes to buy or sell at a certain pre-determined price, but only if the entire order can be filled. As the name implies, if the entire order cannot be filled at the stated price or better, then none of the shares will be bought or sold.
Here is an example of how an All or None order works.
If you put in an order to buy 100 shares of XYZ company at $10 or better, using the All or None designation, but only 50 shares are currently avaible at $10 or better, the trade will not execute at all. If, on the other hand, you had simply placed a Market Order, Limit Order, or Stop Order for these shares, even though you requested a buy of 100 shares at $10 or better, you would have ended up with 50 shares instead.
Good ‘til Cancelled
“Good ‘til Cancelled” is another designation that can be added to a buy or sell order. Good ‘Til Cancelled is basically a time restriction that you place on your order. With a Good ‘Til Cancelled order, you are indicating that you want to buy or sell a specific security at a specific price, but only if it happens within a certain time-period. In general, you can set this time-period to be anywhere from 1 – 180 days. If the trade does not execute within this time-frame, then it is automatically cancelled. This is a great way to try to buy a security at a lower price, or sell a stock at a higher price, when you are not available to regularly check on the price of the security.
The trade execution alternatives discussed above are important to understand, and can be helpful in certain situations, but it is important to understand that they are most often used by traders and speculators, and rarely suitable for long-term investors. For the vast majority of long-term, buy-and-hold investors, using a simple Market Order generally works just fine. As with all things financial, you should consult with your own advisor, CPA or attaorney before making any trades or trying any new investment strategy.
The commentary on this website reflects the personal opinions, viewpoints and analyses of the Topel & DiStasi Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Topel & DiStasi Wealth Management, LLC or performance returns of any Topel & DiStasi Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Topel & DiStasi Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.