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Stock Order Types – Understanding How and When to Use Stock Orders

stock order types
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Getting familiar with the different types of stock orders is the first place any trader should start their journey. Knowing how a limit order works or what stop order types you can use to mitigate your losses is essential. It is a solid foundation for you to build your trading strategy on.

In this guide, we will cover every important detail about the different types of stock orders. From what market, stop, and limit orders are to when to use them and their pros and cons. We will also examine how traders use different stock orders to improve their trading efficiency and risk management strategies.

So, get comfortable, and let’s explore one of the most important topics in the trading world!

Market Orders

If you have ever dealt with trading in any form, you may already have experience with market orders. Whether it is with real money or through a simulator.

A market order is the most basic type of stock order. The trader buys or sells an instrument instantaneously, with no delay and at/close to its current price. If you are buying a stock, you will pay similar to the number displayed as “Ask.” Meanwhile, when you are selling, you will receive an amount close to the number shown as “Bid.”

The ask price indicates the lowest amount sellers will accept for the particular security. Meanwhile, the bid price shows the highest price buyers will pay for it. We refer to the difference between them as a bid/ask spread or just spread. The bigger the spread, the healthier the market is.

Okay, but why are we talking about execution close to the price, rather than at an exact price?

Stock Order Book & Volatility

The reason is that markets nowadays are quite complex. Trading happens at an extremely high speed. The volatility is often high, and the display price rarely manages to reflect everything that happens “behind the curtain.”

In volatile or unstable markets, for example, the last traded price you see on display will most likely differ from the price at which your market order will execute. Although that discrepancy may not be too significant, it may occur, and that shouldn’t surprise you. It is just the way the market infrastructure functions these days.

That is why it is better to say that market orders may not necessarily lock a price to buy/sell at. Instead, they guarantee immediate execution.

However, it is fair to say that for the most liquid markets, the price that your market order will execute at will be pretty close to the one you see on display. A liquid market would be one where instruments are trading in the tens of thousands per day.

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When to Use a Market Order?

You should use a market order when you need to buy/sell an instrument instantaneously. For example – if you trade on real-time news or at excessively high frequencies. Or, in other words – if you use a time-sensitive trading strategy.

Traders usually place market orders when they want a guarantee that the stock order will be executed. Although they may not know the exact price at which it will happen, they know they will be able to buy/sell without delay. That allows them to take advantage of the momentum and capitalize on the expected price changes.

Limit Orders

Limit orders allow traders to buy/sell at a specific price. However, it does guarantee the exact moment the order will be executed. When placing a limit order, you have to set the maximum and minimum price you are willing to buy or sell at. Limit orders execute only when they hit the predefined price levels. If the price doesn’t reach the specific level, the limit order won’t be executed.

The time you may have to wait until your limit order executes depends on several factors. These include, where you place it, how far of the bid/ask price it is, how volatile the particular instrument is, what is the current state of the market, and so on.

Limit orders are also known as “pending orders” because they may be left unexecuted for an extended period or until cancellation.

Pending Stock Orders Simplified

Compare limit orders to buying something from the local supermarket. Although that is an overly simplistic analogy, it should help give you a better understanding. Let us say the price of a bottle of water is quoted at $X. You know that you will pay exactly the same amount to get it. However, the problem is you have to wait in a queue until you reach the cashier. You have no idea how long it will take. What you know for sure, though, is that, once the moment comes, you will pay the price on display.

Let’s see how this works in practice when trading stocks. Assume that you have an interest in buying shares of company ABC that currently trades at $10.80 per share. You set a limit order to buy for $10.50 per share. This guarantees that you won’t pay a penny over that price. Once the shares drop to $10.50, your stock order executes. If they don’t get that low, however, the order will be left pending.

There are two main types of limit orders:

  • Buy limit – a stock order to buy a particular instrument at or below the current bid;
  • Sell limit – a stock order to sell a specific instrument at or above the current ask;

However, there are also the buy stop and the sell stop types of limit orders but we will talk about these in a moment, when we focus on stop orders.

When to Use a Limit Order?

Use a limit order when your trading strategy isn’t time-sensitive, and your main goal is buying/selling at a particular price. For example, if you have clear intentions to go bullish or bearish and want to trade in large quantities once a specific price level is reached.

However, this doesn’t mean short-term traders don’t use limit orders. Just the opposite – traders, willing to capture short-term price changes and are well aware of the characteristics of the instrument they are trading and the probability for its price to reach a particular level often take advantage of limit orders to boost their profits.

Traders also use limit orders when they trade several instruments and can’t keep an eye on each of them all the time. To get the process a bit automated, they can place limit orders at key support/resistance levels, so that they can sell or buy immediately when they are broken.

Also, those trading illiquid instruments or assets with particularly large bid-ask spreads can also take advantage of limit orders to make better trades.

Stop Orders

Stop orders allow you to buy/sell an instrument at its market price once it has reached an initially-set stop price. Once price reaches the stop price, the stop order converts into a market order.

Stop orders are similar to limit orders in the sense that their main goal is to buy/sell at the best possible price. 

Let’s now take a look at buy and sell stop orders. A buy stop order is usually placed above the current market bid and becomes active only when that level is reached. Once this happens, the stock order is converted into a market or a limit order. The sell stop order, on the other hand, is placed below the current market rate and becomes active when the level is reached.

Traders usually place their stop orders on the opposite side they hope the price will go. For example, bullish traders will place stop orders on a lower price level, while bearish traders will place their stop orders at a higher price level. The idea is to prevent or minimize their losses. That is the reason why stop orders are often referred to as “stop-loss” orders.

Stop Orders in Practice

Here is how stop orders work on practice. Let’s say you have significant exposure to the shares of a high-end consumer brand. However, a series of events trigger a global recession, and you expect a decrease in consumers’ spending ability. Your forecasts show that the company will suffer a major drop in profits, and you want to sell the shares you own to mitigate your losses. You expect its shares to go down, but you are not sure about how much.

Let’s say the shares trade at $50. You can place a stop order to sell at $45, for example. If the price drops to that level, your stop order immediately becomes a market order, and your shares will be sold at the best possible price. If your fears don’t materialize and the price doesn’t hit the $45 mark, your shares won’t be sold.

Stop Order Types

There are three main types of stop orders – a stop market order, a stop limit order, and a trailing stop order. The difference between them is rooted in how they function and the way they can help the trader.

Stop market order

Stop market orders, also known as “stop-loss” orders, are among the most widely used. Unlike the limit and market ones, stop market orders don’t get activated until a particular price level is reached. Once this happens, though, the stock order is converted into a market order, and the trade gets executed at the market price.

Here is an example. Assume you want to trade the AAPL stock. If you place a stop-loss sell order at $450, for instance, it will remain inactive until the particular level is reached. Once the price gets to $450, your sell order will be executed and the shares would be sold at the best possible price.

Traders use stop orders when they’re unable to monitor the market consistently. In those cases, they need a guarantee that they can protect their investment. He can simply place a stop market order and get on with other activities as the stock order can remain active for up to 60 calendar days (in some cases more).

Stop limit order

Stop limit orders are very similar to stop-loss orders. However, here we have a limit on the price at which the trade would get executed.

So, the main difference here is that, instead of becoming a market sell order, the stop limit order effectively becomes a limit order that executes only when the limit or a better price is reached.

Aside from that, stop limit orders basically combine the best of both worlds (stop and limit orders). They ensure a particular price but don’t guarantee that the order’s execution at all if prices don’t reach the limit.

Stop limit orders consist of two prices – a stop price and a limit price. To understand the difference, let’s take a look at a simple example. Let’s say that you decide to place a stop-limit sell order with a stop price of $100 and a limit price of $99. In that case, once the price drops to $100, the limit order will get activated. However, the instruments won’t sell unless they can guarantee a price of at least $99 or better. So, in this case, you will sell for anything below $100, but above $99.

Stop limit orders help traders overcome the problem of being triggered unnecessarily due to flash crashes or sudden market dives that are later corrected.

Trailing stop order

Think of trailing stop orders as a more advanced form of the traditional stop orders. They allow you to instruct the order to move in relation to the market price. This grants traders flexibility and enables them to protect and increase their profits without having to watch the market 24/7.

Trailing stop orders are basically automated stop limit or stop market orders. You can set the trigger price either as a dollar amount or as a percentage but always in relation to the market price. For instance – sell the instrument should its price drop by $5 or 3%.

Example

Assume that you buy a stock for $50. Two weeks later, the stock’s price jumps to $55. You can set a trailing stop order that sells the stock immediately if it goes $2 under the market price. If, for example, a few days later, the price drops to $53, the trailing stop order becomes a market sell order. On the other hand, if the instrument jumps to $60, the level for the trailing stop order effectively becomes $58.

What this comes to show is that the trailing stop order follows your instructions and chases the market price. It basically works as a safety net to make you feel comfortable about your positions, without having to monitor the market all the time.

When to use a stop order?

A good case to use a stop order and the assets in your portfolio go up. That way you can try protecting your profits from an immediate correction. You can place a stop order at a level that is close to the market price at which the instruments trade at the given moment. If their price continues to grow, you can move your stock order higher simply by using a trailing stop order.

You can also take advantage of a stop order to buy/sell in scenarios where the price of the instrument you are interested in breaks certain resistance/support levels, and you believe it will continue to rise/fall.

Other Stock Order Types

Aside from market, limit, and stop orders, there are also other stock order types worth knowing about that can potentially help you optimize your trading strategy.

Good-till-Canceled (GTC)

GTC is one of the most popular stock orders among advanced traders. Through the GTC, traders can set a time restriction on their open positions. As its name suggests, the good-till-canceled order remains active until the trader cancels it. Depending on the trading platform or the brokerage company that you trade with, the GTC can have a maximum time limit you can keep your orders active that can go up to 90 days.

All-or-None (AON)

The AON is a limit order used mostly by penny stock traders as it helps ensure that they will trade either the whole quantity they requested or none at all. A major part of the penny stocks lacks liquidity, which often means that the trader won’t be able to take a big position. If he is firm on executing his stock order for its full amount, instead of partially, he can take advantage of the AON order. 

For example, if he wants to buy 5 000 shares, but only 3 000 are available at his preferred price, with the AON, the order won’t get executed at all. Without the AON, he will buy the 3 000 available.

Immediate-or-Cancel (IOC)

On the contrary, the IOC is a stock order, designed for those who want to get in a trade and capture a particular momentum, no matter the quantity available on the market at the preferred price. This means that in cases where the trader wants to buy 1 000 shares initially, for example, even if just 200 are available, the order would get executed. This also cancels the buy order for the rest 800 automatically.

The IOC order is usually preferred by those willing to seize a very short time interval (a few seconds or less).

One-Cancels-Other (OCO)

When using the OCO order, the trader places two separate stock orders. The moment one of them is executed, the other is cancelled. To understand how this conditional order works in practice, let’s take a look at an example.

Assume that you buy a stock at $50, and you have a profit target of 20%. You also don’t want to lose more than 5% of your position. In this scenario, you can place an OCO order that consists of a take profit order at $60 and a stop-loss order at $47.5.

The OCO order will get executed either when the price hits $60 or when it falls to $47.5. Whatever happens, first cancels the other.

Take profit

This type of order is designed to help traders close a trade once a certain profit level is reached. Also referred to as a “profit target order”, it basically closes once the profit target is met. The order usually works in addition to a pending order.

Fill-or-Kill (FOK)

The FOK type of order is a hybrid between the AON and the IOC ones. When applied, it requires the whole amount of the stock order to be executed during a short time frame, usually less than a few seconds.

If the trade can’t be executed in full and within the particular time interval, it gets canceled.

Day Orders

Day orders mandate that a certain position expires with the end of the trading day unless instructed otherwise (for example, if you have set it as a GTC or to execute within a particular expiration time). If the order doesn’t get executed throughout the day, you will have to set it up again on the next trading day.

Differences Between Stock Order Types

The main difference between all stock orders is how popular they are among traders. Understandably, the most popular ones are the traditional market, limit, and stop orders. 

Let’s take a look at a comparison table and find out what differentiates them:

 Market orderLimit orderStop order
DefinitionOrder to trade at the best price availableOrder to trade at a specified priceOrder to trade at the best available price after a specified price is triggered
When to useWhen you want immediate executionWhen you want execution at a specific priceWhen you can’t monitor the market and want to trade under specific rules
Who uses itMostly beginnersAll tradersMostly advanced traders
CostsLowHigherNo costs if not executed. Otherwise – low costs
Price controlNoneFullNone once the stop price is triggered
Price trading atCurrent (close to it)SpecificCurrent (close to it), after a specific price is reached
ComplexitySimpleMediumAdvanced

It’s worth pointing out that most traders consider orders like the FOK, AON, or IOC, for example, a bit archaic today. AON and IOC aren’t so widely used by retail traders as not a big part of them fancy trading penny stocks, where these orders are the most efficient ones. In the case of FOK, the order is entirely conditional, which may often lead to no “fill” and just “kill” (i.e., no execution).

Advantages and Disadvantages of Stock Order Types

Let’s now summarize the main advantages stock order types bring on the table and check out if they have any disadvantages at all.

Stock Order Advantages

Easy-to-understand even by beginners

Even the advanced order types have clear fundamentals that you can easily understand. Even if you’re only just taking your first steps into the financial markets. Learning the basic characteristics of the different order types isn’t difficult. That knowledge includes how they work, when to choose them and how to apply them. Things are quite different when it comes to real-world application though.

Flexibility

The wide variety of stock order types available to traders means there is a suitable tool for every strategy or situation. Stock order types are the closest thing you will find to trading automation. If you learn how to use them, you will guarantee a time-tested and reliable trading assistant to help improve your efficiency.

This also saves you time to focus on chart analysis, research, learning, or whatever you prefer, without having to worry about your portfolio.

Price and momentum control

Depending on the type of order used, you can ensure full control over the price of execution. This means you know where you are buying and selling even before this happens. Aside from that, traders can also specify how long the order remains active, under what conditions it executes, whether partial or complete execution is preferable, and more.

Great hedging tools

Traders can take advantage of different stock order types to minimize the risk facing their portfolio during volatile days when the price swings quickly and wildly. For beginners, this is a great way to ensure peace of mind, while for advanced traders, it gives them more freedom to try risky strategies without having to worry about their portfolio.

Stock Order Disadvantages

Can be hard to master

Although most order types, especially the market and limit ones, are straightforward to understand, it takes time to master how to apply them in the most efficient way. The most complicated thing here is to learn which order type to use depending on the situation and how to combine them.

That is why the best thing to do is to start with a demo account and learn how stock order types work in practice without risking real money. Once you master the mechanics, you can go on and try them out in the real-world.

Can complicate your trading strategy if not used properly

Don’t forget orders are to simplify your trading strategy, not to complicate it. Often, beginner traders concentrate too much on using different types of stock orders, when, in fact, they might not need to. For example, if you are buying an instrument for the long term and have the time to monitor the market, a simple market order might do the job for you.

Don’t immerse yourself too much in using advanced orders with your trading strategy. Especially not if you aren’t 100% confident you need them or have the expertise to use them. Always align the stock order types to your strategy and not the other way around.

Even with them, there are no guarantees

The purpose of different types of stock orders is to simplify and improve your trading. However, they can’t guarantee that things will happen exactly the same way as on paper. Even the basic market orders can’t ensure that you can execute the trade at the exact price you see. That high-speed rate of operation is the nature of financial markets.

That is why make sure to use stock order types only if you are confident you understand them in detail and have tried them out within your demo account.

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