What are Stock Orders?
Stock orders are the different methods you can use to purchase a stock. Think of it like you’re buying toothpaste. If you need it, you can go straight to the closet convenience store and buy it at full price. If you’re not in a rush, you can wait till the toothpaste is on sale for a specific price so you can buy it in bulk.
Stocks work the same way where you have the option to buy or sell immediately or buy or sell at a specific price or better. These orders can be set ahead of time. For example, if Apple stocks are priced at $200 USD now, and you want to buy them for $180. You can set a limit order of $180 and the order will automatically be processed if the price ever drops below $180.
Setting these orders are critical when managing a portfolio yourself because it helps you automatically get stocks at a lower price and it can help minimize losses if you set your orders ahead of time to sell if the price drops to a certain price.
The market order is the simplest order which is an order to purchase at the current asking price. This is like walking into the store and purchasing the toothpaste at the current price.
Think of using limit orders when you want to buy a stock as soon as possible. If you have done your research and the price is right, then a market order is the fastest way to purchase a stock.
A limit order is an order to sell at a higher specified price or buy at a lower specified price. For example, if you’re looking to buy toothpaste and you’re not willing to buy it for more than $1. You can set a limit order to tell the system to only purchase 5 boxes of toothpaste when the price is lower than $1. When a sale comes, the system will automatically execute the order and buys the 5 boxes at a price lower than $1.
Think of using limit orders when you’re looking to automatically realize your gains or purchase a stock at a value.
Stop Loss Order
A stop-loss order is an order placed with a broker to buy or sell once the stock reaches a certain price. A stop-loss is designed to limit an investor’s loss on a security position. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%.
Let say you bought Facebook stocks at $20, and you’re uncertain if it will go up the next month. If you set a stop loss order at $18, the system will automatically sell your stock if the price goes below $18. You see that there is news about a privacy leak on Facebook and Facebook stocks quickly drop.
Because you have a stop loss order in place, the system will automatically trigger a market order to sell your stock when Facebook stock prices drop below $18. Depending on how fast the stock price drops, you are not guaranteed to sell at $18, but a price lower than $18. But with the stop loss order, it will allow you to react immediately to the market versus reading the news yourself and acting on it hours later.
Think of using stop loss orders when you’re looking to protect yourself from losses or buying a stock when there’s upward movement to follow the trend.
Buy Stop Orders
A buy stop order instructs a broker to purchase a security when it hits a strike price that is higher than the current spot price. Once the price hits that strike, the buy stop becomes a market order, fillable at the next available price. This is essentially the opposite of a stop loss order.
You might ask yourself, why would you want to buy at a price higher than a price you set? The first reason is because you might be waiting for news to break out, and you want to act with the market as soon as possible if it’s good news.
For example, if a pharmaceutical company is awaiting FDA approval for a drug that might save million of lives, its stock price depends on the approval. Rather than waiting for the news to break and buying the stock, you can set a buy stop order, so that if the news break and it’s good news, you’re automatically following the market.
A buy stop order is most commonly thought of as a tool to protect against the potentially unlimited losses of an uncovered short position. A short position is when you bet that a stock will decrease in price. How it works is you the trader sells the stock with the intention of purchasing it later at a lower price.
Short positions are very risky because you have unlimited exposure. With a traditional trade, when you purchase a stock for $20, the most you can lose is $20 if the stock price goes to $0. With a short position, the stock can continually to rise with no upper limit. This means if you put a short position on the stock at $20, and the stock rises to $200, now you’ve suddenly lost $180 since you have to purchase the stock back at the higher price.
If you short a stock at $20, you can use a buy stop order at $22 to minimize your loss. This means if the price ever increases above $22, your order will execute to purchase the stock to minimize the loss on your short position to $2.
Think of using buy loss orders when you’re looking to buy a stock expecting the trend to increase or protecting your losses if you have short positions.