Purchasing a share of stock doesn’t have to be a simple transaction. Investors are often presented with a variety of different mechanisms by which they can execute a trade. Scottrade, for example, offers me five: Market, Limit, Stop, Stop Limit and Trailing Stop.
* Market: Market Orders are the most simple, most straightforward means of purchasing a security. Executing a market order just means purchasing shares of a stock at whatever rate the stock is currently trading at. Since market orders are executed at the best available price at the time of execution, inherent market volatility will likely mean you will pay a price that is close to, but not exactly the same as, the price you saw when you initiated the purchase.
* Limit: Limit Orders give the investor a little bit more control over the price that they pay for their shares. With a limit, you specify the highest price that you are willing to pay per share. Obviously, there is risk that the order never gets filled, if the share price does not breach the specified limit.
* Stop: A Stop Order (also known as a Stop Loss Order) is similar to a limit order. A stop order tells your broker to execute a buy market order whenever a stock’s price rises above a certain threshold.
* Stop Limit: A Stop Limit is basically a combination of a stop order and a limit order. When the stop price is reached, a limit order is then executed, meaning once the stop price is triggered, shares are purchased at a rate no more than another specified limit price.
* Trailing Stop: A Trailing Stop does exactly what the name implies. This is most easily illustrated through use of a sell example, as opposed to a buy, which is how we’ve viewed the previous examples. When initializing a trailing stop order on a sell, you specify either percentage drop or a hard drop amount that will be your stopping price. For example, that value can be something like a decline in share price of 10%, or a $2 drop in share price. So if you buy a share at $20 and set a trailing stop of 10%, your broker will enter a market order to sell if the stock price decreases to $18. However, if the stock goes up, the stop price moves with it. For example, if the stock then shoots up to $30 a share, the stop price now become 10% * 30 = $27. In this instance, losses are managed when the share price falls and maximized when the share price increases.
These categories also apply to selling stocks. There exists many more combinations and exotic rules than the five I’ve described above. Learning the different mechanisms by which someone can execute trades can save you some money and make your investing process more efficient – especially if you are moving larger blocks of shares.
Also its nice to be a bit of technical geek when you are talking with other stock traders. People who are really into stocks sometimes have a specialized vocabulary, so its good to be able to speak the lingo.
Michael
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