Beginner’s Guide to Stock Order Types

Thu May 26, 2022, 10:00 pm | by Charles Munyi | No comments

If you’re still a novice trader, one whose strategies haven’t grown toward the more sophisticated side of things, your trade entries and exits might need some guidance. You need to familiarize yourself with stock order types, but this may not make much sense altogether.

We like to look at a stock order as your gateway from concept to action. It’s where you pull the proverbial trading trigger and a market opportunity turns into reality. If you’re still getting into the game, you’ll probably be placing numerous buy and sell orders over the course of your investing career, and you want to ensure you do it correctly. To do that, it helps to familiarize with the different stock order types you can use to complement your investing objectives.

Basic Stock Order Types

It’s important to understand the three basic order types and how they vary in order to use one effectively. Besides presenting an alternative toward entering or exiting the stock market, stock order types can also prevent you from making severe mistakes that are avoidable and potentially costly.

Market Order

A market order lets you buy or sell shares immediately at the next available market price. You’d typically use a market order when you need to get in or out of a position quickly. As fast as market orders are, they don’t necessarily guarantee that you’ll get a favorable fill price, and it may not entirely be the same price you see on your screen when you hit send.

Your order will probably fill within a range near your target price — sometimes nearer and other times further from your preferred price. This is usually referred to as slippage and its severity depends on multiple factors. For instance, a thinly traded stock may have a wider gap between the bid and ask prices, making it prone to greater slippage. Similarly, periods of high market volatility can result in wide fluctuations between bids and asks.

Market orders aren’t entirely applicable in all situations. Other order types — namely stop order and limit orders — may help you make precise entries or exits from the stock market.

Stop Order

A stop order lets you enter or exit a position after a specific price level is attained. Once your activation price is attained, your stop order becomes a market order, filling at the next available ask price (for a buy stop order) or best bid price (for a sell stop order).

Depending on your circumstances and objectives, you can use stop orders to enter or exit the stock market. But what if you’re looking to buy a stock below its current market price or sell above its prevailing price? Limit orders can come in handy.

Limit Order

A limit order simply instructs the broker that you want to buy or sell a stock at a specific price or better. You may also use a limit order to initiate or close out a position.

You’ll likely want to leverage a limit order if you want to buy shares below the current market price. This implies that your order will be activated when the stock trades at or lower than the target price. If you’re a short seller targeting a price higher than the current price, a limit order may also come in handy.

When exploring order types, you’ll likely come across the terms bid and ask. But what exactly do they mean? A bid or the bid price is the highest price you’re willing to pay for a single share of a stock. A buy may happen when the seller agrees to the bid or the buyer adjusts their bid to match the ask price. The ask or ask price is the lowest price you’re willing to receive for a single share of a stock. The difference between the bid and ask price is known as the spread.

How Orders Get Executed

When you place a stock order, you’ll rarely think about how or where your broker will execute the trade. However, these two aspects may impact the overall costs of the transaction, including the price you pay for the stock altogether.

Trading through an online brokerage account doesn’t give you a direct connection to the securities markets. When you hit the enter key, your order is routed over the internet to your broker who then decides which market they’ll send it to for ultimate execution. The process is also similar if you can call your broker to place your trade.

Stock order execution isn’t always instantaneous, and prices can rapidly change in fast-moving markets. Since price quotes are only for a specific number of shares, you’ll not always get the price you saw on the screen or the price your broker quoted over the phone. By the time an order reaches the market, the stock price could be slightly or very different.

Your broker typically has a choice of markets to execute your order:

  • For a stock listed on an exchange, like the New York Stock Exchange (NYSE), your order may be directed to the exchange.
  • If your stock is trading in an over-the-counter (OTC) market, your brokerage will send the order to an OTC market maker.
  • A broker may also route your stock order — particularly a limit order — to an electronic communications network (ECN), which automatically matches buy and sell orders at specific prices.

Types of Limit Orders

Limit orders indicate the lowest price you’re willing to accept to sell a security, or the highest price you’re willing to accept to pay for a security. An order is typically executed at your designated price or even better.

While limit orders help protect your order from sudden market volatility, it also implies that you’ll only sell or buy the security when it attains the price you’re seeking. Also, limit orders aren’t guaranteed to execute. If there are not sufficient shares in the market at your set limit price, it may require multiple trades to fill your order, or the order may not fill altogether. The most common limit orders include:

  • Buy limit order. A buy limit order instructs the broker to buy a stock at your limit price or lower. Your limit price is usually the maximum price you want to pay per share. For instance, a stock’s current price is $12 per share, but the maximum price you want to pay is $10 per share. You’d then set your limit price to $10. If shares are available, your order will be partially or fully filled at your limit price. If the stock price doesn’t drop to $10, your order won’t execute.
  • Sell limit order. When you place a sell limit order, a security is sold at your limit price or higher. Remember, your limit price must be the minimum price you’re willing to receive per share.

Limit orders should be your primary alternative when wanting to have more control on positions. Furthermore, it can be useful when market volatility is on the rise to avoid incorrect order placements.

Other Types of Stock Orders

If you’re looking to add a bit of extra nuance to your trade entries and exits, you can leverage a host of advanced stock order types. You probably want to understand these other order types really well in order to match them to the appropriate context and avoid risky or costly errors.

These order types usually fall into two categories: durational orders and conditional orders. A durational order must take place within a specific time frame while a conditional order must fill under specific conditions.

  • Stop-Loss Order. A stop-loss order is a conditional instruction to your broker. It converts to a market order — which executes at the next available price — as soon as the stock price crosses the stop price. You can place a stop at any price and attach to instructions to buy or sell a security. The idea behind using a stop price is to protect your current position from sharp declines.
  • Stop-Limit Order. A stop-limit order lets you bring in an additional trigger to your trade — you set a price range for trade execution, setting the price at which an order should activate as well as the limit price at which it should execute. You’re essentially saying “I want to buy (sell) at price X but not any higher (lower) than price Y.”
  • Fill or Kill. Choosing a fill or kill order (FOK) indicates that you want the immediate sale or purchase of a specified amount of stock at a specific price. If the order can’t be filled immediately and, in its entirety, your order is automatically canceled.
  • All or None. Choosing the all or none (AON) order indicates that you want your order to execute in its entirety or not at all.
  • Take Profit. A take profit order instructs the broker to sell a security once it hits a certain level of profit. Selling at this price will ensure you make a profit on the trade.
  • Good till Canceled. This durational order simply means “Keep my order active until I cancel it.” While these orders will remain open until you cancel them, brokers often place time limits like 90 days to prevent a long-forgotten order from processing years later.

Final Thoughts

Since a stock order is usually the first step toward placing live trades, it must be done carefully and accurately. Knowing the stock order type to use for a certain situation will help you minimize your blunder and increase the likelihood of reaping profits when entering or exiting markets.  

Irrespective of the type of order you choose, you can’t entirely eliminate the market and investment perils. You can’t anticipate when market volatility will swing in, so it’s important that you decide what’s essential to you depending on your goals and objectives. For all transactions, check the order confirmation you receive from your broker to ensure the fees, price and order information are accurate.

Disclaimer: Benzinga is a news organization and does not provide financial advice and does not issue stock recommendations or offers to buy stock or sell any security. Benzinga Pro is for informational purposes and should not be viewed as recommendations. Benzinga Pro will never tell you whether to buy or sell a stock. It will only inform your trading decisions. You can find our full disclaimer located here.