Be they market orders, limit orders, or stop orders, these order types can limit risk and help you trade at the price that works for you.
Research, preparation, and a solid trading plan can set up a trader for success, but even the most organized traders can’t anticipate everything that happens in the markets. One of the most daunting parts of this industry is managing risk, and acknowledging that some elements are outside a trader’s control can be emotionally draining.
A trader does control some amount of risk, though. Placing an order on a security can limit the risk on a trade and potentially limit loss. Whether your goal is to buy a security before the price rises too high or sell before the price plummets, these order types may help you reach your goals without feeling completely powerless.
In what may be the simplest type of order, a market order is an order to buy or sell a security immediately until the order is filled. This type of order ensures that the order will happen, but it doesn’t necessarily guarantee the price of the order.
Generally, traders who use this order are more concerned with speed than price. The last-traded price may not be the same price as it was when the market order was placed, especially in fast-moving and volatile markets. Because of this, traders tend to use a market order during trading hours and in highly liquid markets. For example, there may be a significant difference in price if an order is placed after hours versus what the price is when the market opens the next day.
The trader sets a price at the start of a limit order. Then, the order won’t be bought or sold until the security reaches that price or better. The limit order is useful in helping to prevent investors from purchasing or selling a security at a price they don’t want. If the market price does not match the price of the limit order, the order will not execute. Traders use this when they have a target entry or exit price.
The limit order has several subcategories, depending on the goal of the order.
● The buy limit is an order to buy a security at or below the price of the order.
● The sell limit is an order to sell a security at or above the price of the order.
● The buy stop is an order to buy a security at a price above the current market bid.
● The sell stop is an order to sell a security at a price below the current market asking price.
Though limit orders can limit risks, they do still rely on a certain degree of chance. In some cases, a short-term, intraday price move may result in an execution price that is considerably worse than the stock’s closing price for the day.
A stop order buys or sells a stock when it reaches a predetermined activation price. When the market reaches that price, the stop order becomes a market order. This helps to limit an investor’s loss on a position. However, much like a regular market order, the stop price is not guaranteed to be the execution price; the stop price is only a trigger for the stop order to become a market order, and the price may change in a highly volatile market.
An investor can limit the risk of a stop order executing at an unintentional price by placing a stop-limit order, which is a stop order to sell that is linked to a limit order. Just like the limit order, the stop-limit requires the order to hit the limit price or better.
In addition to stop-market and stop-limit orders, a third type of stop order is the trailing stop order. With a trailing stop order, the trade sets a certain amount above or below the market price instead of setting a specific activation price. As the price of the security moves in an advantageous direction, the trailing stop price follows by the specified amount. On the other hand, if the security’s price moves in a disadvantageous direction, the trailing stop price will stay the same. If the security’s price matches the trailing stop price, the order is triggered.
When setting a trailing stop order, investors should consider whether they want to set a percentage or fixed-dollar price for their trailing stop price. Moreover, investors looking to hold onto the security should be wary about the price they choose, as short-term market fluctuations may prematurely activate a trailing stop order. During more volatile markets, a wider trailing stop may be a safer choice.