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Market, Limit, and Stop Orders
Market Order
A market order must be executed at the best price available when the order reaches the market maker. Please remember that the price at which your order is finally executed could well be different from the quoted price you got for yourself before you placed your order. Again, the reason is that the market is dynamic. Prices are changing continuously as the minutes and seconds go by. Market orders guarantee an execution but they do not guarantee an execution at a specific price. Large orders can take longer to fill and can move the market for that stock.
Limit Orders
In contrast to the market order, there is another type of order called a "limit order" that does in fact guarantee a price but not an execution. Limit orders are so named because you place a limit on the amount you are willing to pay to buy a stock or on the amount you are willing to accept to sell a stock. Naturally, you will accept more favorable prices if you can get them. Here's how limit orders work using Disney as an example.
Buy Limit Order
DIS is selling for $84 a share. Based on your experience, you think the stock could decline in the short-term and then rebound strongly upward. So you place a limit order GTC (Good Till Canceled) to buy DIS at $81. (Any price different from the current market price is said to be "away from the market." Limit orders are always placed away from the market - below when you buy and above when you sell.) Now the broker/dealer's computers monitor your order and when the stock price hits $81 your limit order is executed.
Sell Limit Order
You own Disney which is trading at $84. You think the stock can still go higher to, say, $90. But then you expect it to drop. You want to ride the stock higher but you want to get off before it drops too far. So you place a sell limit order at $88.
Risks of Limit Orders
Limit orders give you more control over execution price, but that very control also comes with certain drawbacks that you should be aware of:
Miss owning or selling stock. The stock may never reach your limit price and your limit order will not execute. For example, in the Sell Limit Order example above, if Disney only reached $87 and then started to fall, your limit order would not have executed and you'd still own the stock as it drops.
Fail to execute. Even if your stock reaches or passes through the limit price, your limit order may not execute if there are orders ahead of yours at the same limit price. The orders in line ahead of you on the Specialist's book must be filled first and there may not be enough stock available to fill your order when its turn comes.
Stop Orders
Stop orders are mainly used to limit loss on profitable long or short positions which is why they're also called "stop loss" orders. Although they resemble limit orders, stop orders have one feature in particular that sets them apart. Unlike a limit order which can be filled only at a specific limit price, when a stop order reaches its stop price, the stop order becomes a market order to be executed at the best price available. As a result, there are trading situations where the stop order could end up getting executed at a price that is significantly higher or lower than the stop price and potentially unfavorable to the investor. Stop orders are not allowed on OTC Bulletin Board (Pink Sheet) stocks or on foreign securities.
Buy Stop Order
The buy stop is frequently used to protect the profits of a successful short sale. Let's say you shorted Disney at $89 and the stock subsequently dropped to $82. Concerned that the stock could start going up, you place a buy stop order at $83 to cover your short position and protect your profits. If it's a listed stock, the stop order becomes a market order when the stop price on the primary exchange is traded at $83. If it's an OTC stock, the stop order becomes a market order when the ASK price hits 83.
Sell Stop Order
You bought Disney at $80 and it's gone to $89. You think it's headed down so you place a sell stop order at $88 to protect most of your profit. If the stock hits 88, your sell stop order will be triggered and become a market order. At that point, your order is then eligible for the next available price in the market which could be lower than 88.
Stop Limit Order
The stop limit order can be used to buy or sell. It is a regular stop order that becomes a limit order rather than a market order when the stock hits the stop price. With the stop limit order, an investor is trying to be even more precise about what price is acceptable. In the E*TRADE system you must place your stop and your limit at the same price. Thus, a sell stop limit order in the sell limit example for Disney above would be placed as "sell Disney at 88 stop, 88 limit" meaning: "I want out at 88 and not less than 88".
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