How The Right Buy and Sell Orders Boost Your Profits
Let's say that you are about to place a market order with your broker. It's simple and frequently used, but it can cost you money. A market order instructs your broker to buy or sell shares at the prevailing price. Although your order probably will be executed a minute or two after it leaves your broker's hands (or even faster if you make your transactions online), as much as 10 minutes can elapse from the time you begin your call to your broker until your trade actually takes place.
That may not pose a problem on slow trading days, but if stocks are rising or falling rapidly, the price when your shares are sold may be different from what you expected it to be when you first decided to sell. For example, when the DJIA falls some 30 points in half an hour, a volatile $40 stock could drop as much as $2 while you are talking to your broker.
Fortunately, there are other ways to place orders that can protect you against rising or falling prices if you are a buyer, and won't cost you any more in commissions. By selecting the right type of order, a shrewd investor can reduce his risk and pick up a little extra profit.
One common alternative to a market order is a simple limit order. With it, you specify the maximum price at which you are willing to buy or the minimum at which you would sell.
Limit orders at a given price are executed in the sequence that they are received by the specialist handling the issue on the floor of the New York or American exchange. Orders that are bought and sold through the NASDAQ are executed in sequence by an automated system. This means that if your stock trades only briefly at the limit, your order may not be among the ones that are filled.
There is however a simple way to jump ahead of the line since most investors set limits at round-number prices, so you can place yours a fraction of a point higher or lower.
The risk that other orders may be filled before yours points up the main disadvantage of limit orders: you have no guarantee that you will actually buy or sell your shares. When you place a limit order, therefore, you have to specify the length of time that it will be effective. If you don't, your broker will assume that the order is a day order - one that will be executed only if the stock reached the price limit during that day's trading. The alternative is an open order, also known as a good-till-canceled order, which will remain in force until it is filled or you call your broker and explicitly cancel it.
To get a feel for an appropriate limit price, follow a stock closely for a month, noting how much it moves when the overall market has strong up or down days. A limit order too close to a stock's current price will not produce much more profit than a market order, while a limit too far away may never be filled. As a rule of thumb, you should set a limit at a price where the stock has traded within the past 30 days and no more than 10% away from the current price.
Market and limit orders are usually the only types available on OTC stocks, but New York and American exchange issues allow for other orders, the most important of which is known as the stop-loss. This order essentially sets a floor beneath a stock in which you have a prior profit - or a price ceiling on a stock that you have sold short. When a stock trades at or beyond your stop price, your shares will be sold as soon as possible at the market price.
For example, if you bought a certain stock at $61 in January and were holding it at $67 now, you could protect half of your profit by setting a stop at $64. If the stock declined by $3, your shares would automatically be sold, locking in $3 of profit.
With a good-till-canceled stop, you would adjust the stop price as your stock appreciates. Using the same example above, you would raise your stop from $64 to $67 if the stock hits $70. This strategy is called using trailing stops.
Setting a price on a stop presents the opposite problem of choosing a buy limit: your objective is to pick a price far enough below the stock's current level that the stop is unlikely to be triggered by day-to-day fluctuations. Set the stop about 5% below the current level of a stock you own, so that you will be sold out only in a serious declne.
There is one type of order to avoid: the discretionary order, which allows a broker to buy or sell as he sees fit. Discretionary orders create potential conflicts of interest for the broker and can land you in an arbitration dispute. Since it is your money at stake, you should take the responsibility for buying and selling.
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That may not pose a problem on slow trading days, but if stocks are rising or falling rapidly, the price when your shares are sold may be different from what you expected it to be when you first decided to sell. For example, when the DJIA falls some 30 points in half an hour, a volatile $40 stock could drop as much as $2 while you are talking to your broker.
Fortunately, there are other ways to place orders that can protect you against rising or falling prices if you are a buyer, and won't cost you any more in commissions. By selecting the right type of order, a shrewd investor can reduce his risk and pick up a little extra profit.
One common alternative to a market order is a simple limit order. With it, you specify the maximum price at which you are willing to buy or the minimum at which you would sell.
Limit orders at a given price are executed in the sequence that they are received by the specialist handling the issue on the floor of the New York or American exchange. Orders that are bought and sold through the NASDAQ are executed in sequence by an automated system. This means that if your stock trades only briefly at the limit, your order may not be among the ones that are filled.
There is however a simple way to jump ahead of the line since most investors set limits at round-number prices, so you can place yours a fraction of a point higher or lower.
The risk that other orders may be filled before yours points up the main disadvantage of limit orders: you have no guarantee that you will actually buy or sell your shares. When you place a limit order, therefore, you have to specify the length of time that it will be effective. If you don't, your broker will assume that the order is a day order - one that will be executed only if the stock reached the price limit during that day's trading. The alternative is an open order, also known as a good-till-canceled order, which will remain in force until it is filled or you call your broker and explicitly cancel it.
To get a feel for an appropriate limit price, follow a stock closely for a month, noting how much it moves when the overall market has strong up or down days. A limit order too close to a stock's current price will not produce much more profit than a market order, while a limit too far away may never be filled. As a rule of thumb, you should set a limit at a price where the stock has traded within the past 30 days and no more than 10% away from the current price.
Market and limit orders are usually the only types available on OTC stocks, but New York and American exchange issues allow for other orders, the most important of which is known as the stop-loss. This order essentially sets a floor beneath a stock in which you have a prior profit - or a price ceiling on a stock that you have sold short. When a stock trades at or beyond your stop price, your shares will be sold as soon as possible at the market price.
For example, if you bought a certain stock at $61 in January and were holding it at $67 now, you could protect half of your profit by setting a stop at $64. If the stock declined by $3, your shares would automatically be sold, locking in $3 of profit.
With a good-till-canceled stop, you would adjust the stop price as your stock appreciates. Using the same example above, you would raise your stop from $64 to $67 if the stock hits $70. This strategy is called using trailing stops.
Setting a price on a stop presents the opposite problem of choosing a buy limit: your objective is to pick a price far enough below the stock's current level that the stop is unlikely to be triggered by day-to-day fluctuations. Set the stop about 5% below the current level of a stock you own, so that you will be sold out only in a serious declne.
There is one type of order to avoid: the discretionary order, which allows a broker to buy or sell as he sees fit. Discretionary orders create potential conflicts of interest for the broker and can land you in an arbitration dispute. Since it is your money at stake, you should take the responsibility for buying and selling.
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posted by Bob Moser at
6:05 PM
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