Stock Order Types

Stock order types are one of the day trading secrets to ensure profitability for active traders. Knowing how and when to use what order type makes the order routing process straightforward.

Best Stock Order Types

  1. Market Orders
  2. Limit Orders
  3. Stop Orders

Market Orders

Most traders use market orders to execute their trades. The main benefit of using a market order compared to other stock order types is that the order gets filled with the full number of shares you ordered. The most significant disadvantage is that you never know the exact order execution price until the order got filled.

Let's say you send a market order to buy 10,000 shares of Apple. The price per share at the moment you type in the order is $150 per share. What does this mean to your trade execution price? It means nothing! Why?

We first have to look at a more complex environment, the order book. The order book collects all existing buy and sell orders. As an investor, you usually see two more main variables in your trading platform when you open the ticker of your choice. You see the price, the ask, and the bid.

The price reflects the price where your shares changed the ownership the last time when a buyer met a seller of a share. The asking price reflects the best possible price a buyer can get right now, while the bid price reflects the best possible price a seller can get right now.

Using a market order does not guarantee that your trade is executed at the price, bid, or ask. That's because of the number of shares behind the best bid and the best ask. If there are only 100 shares offered at a price of $150.10 per Apple share and you send a market order to buy 10,000 shares, then the first 100 shares of your order might get filled at $150.10, but the other 9,900 shares get a fil at a price above $150.10.

I do not want to get too much in detail since there are also hidden shares in your order book, or iceberg orders that traders can use the incrementally allocating new shares to a specific price. For 99.99% of traders, the basic concept is entirely sufficient. The most important thing you need to understand is that the market order does not guarantee any specific price where your trade gets executed. Still, the chances are pretty high that your order gets completed entirely.

If you send a market order during trading hours to buy 10,000 shares of Apple, you get 10,000 shares of Apple.

When To Use a Market Order?

Traders use market orders when they need to buy or sell an underlying asset immediately. Let's say news came out, and the stock price surges with high momentum. Chances of short-term retracements are low, and you want to scalp a few cents by riding the momentum. In this case, you want to get in fast and also want to get out fast.

To open your position, use a buy market order and close the position using a sell market order. Two things to consider are the spread between the bid and ask and the trading volume. The spread reflects the difference in price between the bid price and the ask. The higher the spread, the higher the chances of bad fills. Low trading volume often leads to high spreads and high spreads to bad fills. In short, the higher the trading volume at the time where you get active, and the lower the spread between the bid and ask, the better the order execution will be.

Limit Orders

Limit Orders are an excellent way to ensure executing a trade for a specific price per share. Getting back to our example, you want to buy 10,000 shares of Apple, and you use a limit order of $149.90 while the current stock price is at $150.00 right now. In this case, your order will become part of the bid side of the order book. You are offering to buy 10,000 shares of Apple at $149.90. If the price per share falls from $150.00 to $149.90 and other market participants are willing to sell 10,000 shares for $149.90, you get your trade executed at exactly the price you have chosen.

But here is the deal with your limit order. Let's say the price per share at the time when you sent the order to your broker was $150.00. After that, the price falls to $149.90 but did not get any shares in your account. After touching $149.90, the price per share immediately goes up another $5 to $154.90 per Apple share. How could that happen? You expected the price to rise, and you see on your chart that the price of your limit at $149.90 got touched.

But what if your portfolio is empty? How could that happen? There are other market participants, and they may get a fill before you did since their order was in the order book at the same price but earlier. Touching a limit order price is never a guarantee for a fill. But if you would have seen $149.89 on your chart, even if only one share was traded for $149.90, then your order would have been filled with high probabilities. Again, there are some exceptions to this, relying on what electronic communication network (ECN) or exchange your order was placed. But also, I do not want to make it too complex here. 99% of the time, your order got filled if the price fell below your order limit.

When to Use a Limit Order?

Traders use limit orders when they want to ensure a trade execution at an exact price per share. Day traders also use this type of order when they can benefit from exchange rebates by providing liquidity. Investors only use limit orders when the current price per share is far away from the price they are willing to pay. Let's talk about Apple again. The shares are at $150.00 right now, and a long term investor wants to use the average effect to reduce the price per share in his portfolio.

The price per share he has in mind is $130.00. He opens the brokerage platform and sends a buy limit order for 500 shares at a limit price of $130.00 to the exchange. If he gets a fill at this price, he got what he wants. If the price never looks back, he is also okay with the situation since his shares in the portfolio are going higher. But let's say the same investor considers adding some Apple shares at $149.90 when the stock price is currently at $150.00 per share. Is this a good idea? Probably not because 10 cents are not reasonable to face the risk of not getting filled. It depends on your trading strategy if you use a limit order or a market order at the current market price.

Stop Orders

Stop orders are important to protect your open positions. You can use a stop limit order or stop market order to protect your position by placing this type of order. If you bought the stock XYZ and the stock reaches your stop price, your stop-loss sell order will be executed as soon as the price is reached. It is important to understand that a stop order is never a guarantee for a fill at a specific price or if you get filled.

A sell stop market order leads to your trade's immediate execution at the best available price, while the sell stop limit order gets triggered when the stop price gets hit. Market volatility and market conditions can cause considerable problems in your portfolio if you use limit orders for the protective stop. It usually is this way to have a specific trading plan with exact parameters on when to buy and sell a stock. And if the stock price gets hit, then you want to get out as fast as possible. That's why most traders and investors use a sell stop market order to protect a position. If your order is filled, the shares in your portfolio will disappear, and you see the transaction in your order history.

When to Use a Stop Order?

Using a stop order is mainly essential to short-term traders. Day traders often use the leverage effect by trading on margin. It becomes important to protect the open position by actively placing stop loss orders once the positions are opened. The stop loss order will protect you, and once the trigger price got hit, the stop order gets executed. Long-term investors usually don't use stop orders because they make their investment decisions mainly based on fundamental data. In this case, a stop would be triggered if parameters like earnings per share or the dividend paid changes in a way the investor is unwilling to tolerate. A stop order is used if the criteria for the stop is the price per share.

Order Type Duration

The duration of an order is another important aspect you need to consider. Some orders are only valid for one trading day, and others are valid good til canceled. Different trading platforms use different variations to describe the order duration. But they are usually correspondingly and easy to understand. Day traders focus on order types valid for a day, while swing traders use so colled good til canceled orders. An order limited to be valid for a day will be canceled automatically once the trading day is over, while the GTC order remains active as long as you keep it active. Two more other order duration types are GTC+ orders, which are valid for 90 days and Good Till Date (GTD), which remain active until the exact date chosen.

Stock Order Types Summary

Stock order types empower traders to efficiently increase profitability and trade execution quality, depending on the preference. Market orders ensure immediately trade executions to the best possible price, while limit orders ensure a trade execution to a specific price but without the guarantee of a fill.

Your broker offers different order types, and it is important to check the exact trading platform features to ensure the correct implementation. If you plan to short stocks, you should consider that the stock order types also exist in this direction, but your broker may have another name for it. If you short a stock, you may see a buy to cover order, and you can add marke or limit as a variable to it. The more complex your trading activities, the more complex the order types. Make sure to practice order type placements in a trading simulator first.

About the Author: Alexander is an investor, trader, and founder of daytradingz.com. After devoting many years to educating himself on powerful day trading techniques and effective investment styles, he started trading and investing more actively. In the past 20 years, he has executed thousands of trades. In 2015, he began writing articles about trading, investing, and personal finance. He is very passionate about sharing his knowledge and strives for success in himself and others. Alexander has been featured on Benzinga, Futures Magazine, and ESI Money.

Updated: October 26, 2020
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