Understanding Different Order Types for Trading

To accomplish the objective of a trade, you must use the proper order. A market order may be appropriate in some situations, a limit order in others, and stop orders can be used in a variety of situations. It's therefore important to understand the different types of orders and know when to use each one.

A market order is an order to buy or sell a stock at the current price being offered by the market. That does not mean, however, that the order will be filled at the price you're quoted. Market orders are filled on a first-come-first-served basis, and if the stock's price has risen or dropped by the time your order reaches the head of the line, it will be filled at the then-current market price, whatever that may be. In other words, market orders ensure that your order will be filled, but they don't guarantee the price at which the order will be executed.

A limit order is an order to buy or sell a stock at or better than a specified price. Using a buy limit order, you may get the stock for less than your specified limit price, but you'll never pay more than that limit price. With a sell limit order, you may be able to sell the stock for more than your limit price, but you'll never receive less than that amount. The disadvantage of limit orders is that in a fast-moving market you may miss buying or selling the stock altogether. They can, however, protect you in volatile situations. Limit orders are also filled first-come-first-served, and by the time your order is up for execution, any price move may have exceeded your specified price. A limit order, then, will prevent you from paying more (or selling for less) than your specified limit price, but it doesn't guarantee that your order will be filled.

A stop order can limit your losses or protect profits. It may be called a stop order, a stop loss order, or a stop limit order. On a long market position, a stop order can be used to sell your stock at a specified price that's lower than the current market price. If your market position is short, you can use a stop order to buy the stock at a specified price that's higher than the current market price. When you set the initial stop, the basic intention is to limit your losses. As the stock price increases (on a long position), the stop can be moved up to lock in your profits; this is known as a trailing stop. You can also use a trailing stop to protect your profits in a short position.

The buy stop order is different from the stop orders previously described. It's actually not a stop order at all, but a unique type of limit order that's used to buy a stock after the stock has exhibited trading strength. For example, if a stock is trading at 20 and you don't want to pay more than 19, you'd use an ordinary limit order set at 19. A buy stop order, on the other hand, would instruct the broker to buy the stock if and only if it reaches a specified price. Again, if the stock is trading at 20, you might enter a buy stop order for 21 to ensure that the stock has enough momentum to keep on moving upward. The buy stop keeps your order from being executed if the stock is too weak to reach that specified price.