LIMIT ORDERS AND STOP ORDERS

Usually, when you buy or sell a security, you are using a market order.  A market order is executed immediately, and you accept the best price the market offers at that moment.  Picking the right type of order when you buy securities can greatly reduce your investment risk.  A limit order can be used to specify the price at which you are willing to buy or sell your security instead of accepting whatever price the market gives you.  It tells your broker to buy or sell a security, but not beyond a certain price. This allows you to limit the price at which you buy the security (a maximum buy order) or the price for which you will sell your security (a minimum sell order). However, a limit order does not guarantee that your request will be filled.  Limit orders are filled in the order in which they are placed.  If there are other orders ahead of yours, stock prices could continue to rise or fall before yours is executed. This technique provides you with more control over the price at which you trade a security, but carries the risk that you may miss opportunities if the market never achieves the target price.  A stop order is another method that you can use to manage your investments in a volatile market. If you own a security or have sold short and are concerned that the market may move against you, then you can place a stop order with your broker to buy or sell securities when the market hits a trigger price. A sell stop order is set at a price below the current market price, and a buy stop order is set above the current market price. This way, you can preserve profits of securities you are holding and protect against large losses when you sell short.  However, unless a limit is also placed, you must accept the price that the market gives you.

What's the difference between a limit order and a stop order?  With a limit order, you are expressing a desire to buy or sell, but only if the desired price can be obtained.  You are determining the price that you want, the minimum at which you will sell, and the maximum at which you will buy.  With a stop order, you are not specifically interested in buying or selling, but more interested in protecting a current position if the market moves against you.  You are determining when you will buy or sell based on market prices, but you do not determine the price that you will get once the action is taken, unless you are using a stop limit order.

Unless noted otherwise, all orders are day orders, which means that the orders are cancelled at the end of the day if they have not been executed.  You can leave open the time by which your order must be executed by using a good-'til-canceled order. It remains open until the order is executed, until you tell your broker to cancel it, or for up to six months ending the last business day of April or October.  There are also fill and kill orders, which require the order be filled immediately or be cancelled.

You can also try to protect yourself against investment risk by using a process called hedging. Next, we will discuss this technique.