Market, Limit, Stop and Day Orders

Russell L. Forkey - Investment Lawyer - Representing Clients in the Southeast United States.

When buying or selling a security, especially when using an online trading platform, it is important that investors understand the various choices that they can utilize in placing an order for a proposed transaction. Each choice carries with it its own set of unique characteristics. Therefore, it is important that an investor understand characteristics and the effect that his or her choice will have on the proposed transaction. This discussion assumes that the investor has correctly communicated his or hers choice to their account executive or has properly filled out the on line order form.

Please keep in mind that this information is generic in nature and is being provided for educational purposes only.  Thus, it should not be considered as legal or investment advice,  If you have any questions concerning the below information, you should contact an experienced legal or financial professional.

In the case of a dispute with your broker/dealer and/or account executive, the date and time of the purchase or sell order that is placed could have an impact on various issues that would arise. For example, let's say that there is an issue as to whether or not a trade was authorized by the client. Put another way, the account executive made an unauthorized trade or it was not executed anywhere close to the price that was indicated. How does the client show that a mistake or unauthorized trade was made? It is not that difficult especially if the account executive has to get the approval to do the transaction, from the client, before the trade takes place ( a " non-discretionary account ). Check the time stamp on the order ticket against the client's and/or firm's telephone records. If there was no phone call on the day of the transaction, it would be an unauthorized trade. If a phone call did take place, how long before or after the time stamp on the order ticket did the conversation take place. If the call was after the trade, it would be unauthorized. If the call was before the transaction, the greater the time between the call and the placing of the order, the greater the presumption that the trade was unauthorized.

The above information is designed to be generic in nature to generally reflect some circumstances that may be important to your claim. However, it does demonstrate why it is important to retain experienced counsel.

What is a Market Order?

A market order, the most frequently used type of order, is an instruction to buy or sell a stock at the best available price when the order is executed. Unless you specify otherwise, your broker will enter your order as a market order.

Market orders are given priority in the communications systems of brokerage firms, so the stock is purchased before the price changes much. Market orders generally are executed within a few minutes (or even a few seconds) of being placed. In a few situations, a market order might not be executed, when curbs are in effect on the exchange floor, for example, or when the trading of that particular stock has been halted.

The advantage of a market order is you are almost always guaranteed your order will be executed (as long as there are willing buyers and sellers). Depending on your firm's commission structure, a market order may also be less expensive than a limit order.

The disadvantage is the price you pay when your order is executed may not always be the price you obtained from a real-time quote service or were quoted by your broker. This may be especially true in fast-moving markets where stock prices are more volatile. When you place an order "at the market," particularly for a large number of shares, there is a greater chance you will receive different prices for parts of the order.

What is a Limit Order?

A limit order is an instruction to buy or sell a stock at a specified price. The specified price can be different from the market price. To avoid buying or selling a stock at a price higher or lower than you wanted, you need to place a limit order rather than a market order. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. When you place a market order, you can't control the price at which your order will be filled.

The length of time that the order stands before being executed depends on the instructions you give to your broker. Using a good-till-canceled order, you can have the order remain active until it is either executed or canceled. If a time limit is not specified, the order is assumed to be a day order; in that case, if the stock price does not fall or rise to the limit price, the order is canceled at the end of the day.

For example, if you want to buy the stock of a "hot" IPSO that was initially offered at $9, but don't want to end up paying more than $20 for the stock, you can place a limit order to buy the stock at any price up to $20. By entering a limit order rather than a market order, you will not be caught buying the stock at $90 and then suffering immediate losses if the stock drops later in the day or the weeks ahead.

Remember that your limit order may never be executed because the market price may quickly surpass your limit before your order can be filled. But by using a limit order you also protect yourself from buying the stock at too high a price. Some firms may charge you more for executing a limit order than a market order.

What is a Stop Order?

A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. You can use a stop order to protect existing profits or reduce losses. Although a stop order might appear similar to a limit order, they have some differences.

A stop order differs from a limit order in that after the stock's price reaches the stop-order price, the stop order becomes a market order. Suppose that you buy some stock at $20 per share that is now trading at $30 per share. Selling those shares would result in a $10 per share profit. To protect this profit from a rapid price drop, you can place a stop order to sell at $28 per share. If the stock drops to $28 per share, the stop order then becomes a market order and is executed at the prevailing market price. If the stock is sold at $27.25 per share, you have protected a profit of $7.75 per share. In the other hand, if the stock keeps increasing from $30 per share after the stop order is placed, the stop order lies dormant (if it has not time limit and is a good-till-canceled order) until the share price falls to $28. In addition to protecting profits, stop orders can be used to reduce or prevent losses.

Buy Stop Order - Investors typically use a stop order when buying stock to limit a loss or protect a profit on short sales. The order is entered at a stop price that is always above the current market price.

Sell Stop Order - A sell stop order helps investors to avoid further losses or to protect a profit that exists if a stock price continues to drop. A stop order to sell is always placed below the current market price.

The advantage of a stop order is you don't have to monitor how a stock is performing on a daily basis. The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price. Also, once your stop price is reached, your stop order becomes a market order and the price you receive may be much different from the stop price, especially in a fast-moving market where stock prices can change rapidly. An investor can avoid the risk of a stop order not guaranteeing a specific price by placing a stop-limit order.

The use of stop orders is much more frequent for stocks that trade on an exchange than in the over-counter (OTC) market. In addition, your broker-dealer may not allow you to place a stop order on some securities or accept a stop order for OTC stocks. Before you enter into these types of orders, you should speak to your broker or financial advisor about how these orders work.

Although it is not discussed herein, you can use stop orders to protect profits on a short sale or to reduce or prevent losses on the transaction.

What is a Stop-Limit Order?

A stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order. Once the stop price is reached, the stop-limit order becomes a limit order to buy or to sell at a specified price.

The benefit of a stop-limit order is that the investor can control the price at which the trade will get executed. But, as with all limit orders, a stop-limit order may never get filled if the stock's price never reaches the specified limit price. This may happen especially in fast-moving markets where prices fluctuate wildly.

The use of stop limit orders is much more frequent for stocks that trade on an exchange than in the over-counter (OTC) market. In addition, your broker-dealer may not allow you to place a stop limit order on some securities or accept a stop limit order for OTC stocks. Before you enter into this type of order, you should speak to your broker or financial advisor about how the order works.

The above information is being provided as general market information and is not designed to constitute legal or market advise.

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