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Order Types Explained - Market/Limit/Reserve/Stop

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  • Order Types Explained - Market/Limit/Reserve/Stop

    When trading and investing there are several types of orders you can use to buy or sell your stocks. Most of these apply to other instruments too but for the sake of this article, we will focus on stocks. Let's get started:

    Market Order- Market orders are the simplest type of order to place. They are used when you as the trader or investor aren't terribly concerned with the price you pay for buying or selling your stock. Most traders don't use market orders because getting an exact fill price is more essential than when investing long-term. For example, if a trader sees a $50 stock and thinks it will go to $52 as his price target h would never use a market order because the broker he uses could fill his order at $50.25. If the trader was planning on putting on a 10K share position he would have missed out on an extra $2500 profit. The trader in that example would use a limit order instead.

    An investor or the other hand could very well use a regular market order to buy stocks. If we use the same $50 stock example but change the price target to $100 or $150 then you start to realize that getting in an extra $0.25 higher than you wanted isn't as big a deal.

    Limit Order - Limit orders allow traders to control exactly what they will pay for buying or selling a stock. To place a buy limit order you will fill in the order form on your brokerage account like this:
    Click image for larger version  Name:	AAPL limit order.jpg Views:	0 Size:	39.3 KB ID:	6145

    As you can see in the image above the trader here wants to buy 1000 shares of Apple. He is about to place a limit order to ensure he pays no more than $320.50 per share.

    The same can be applied to selling a stock...just do the inverse. See image below:

    Click image for larger version

Name:	AAPL sell limit order.jpg
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    The trader in the selling example wants to get out of AAPL no lower than $320/share. If he gets out lower than that he will have a loss larger than what he is comfortable taking.

    When placing limit order all you have to do is ask your one question whether you're buying or selling:

    When buying: How far up do I want my broker to go to get me into this stock

    When selling: How far down do I want my broker to go to get me out of this stock

    Stop Order -Stop orders are basically open orders that aren't executed until a certain action occurs with your stock. Read below to get a detailed explanation about the two main types of market orders.

    Stop market order - Stock market orders can be used to buy or sell a stock once the stock reaches a certain point. For example, if you are in a $50 stock and you set a stop market order to be executed at $5 that means your broker won't touch your shares until it reaches $45/share. Once it reaches that point your broker will get you at whatever market price is available. See the explanation of market orders above to understand the pros and cons of using them.

    Stop limit order - A stop limit order is just like a stock market order but the main difference is you can get more specific with what price you allow your broker to buy or sell your stock at.

    Reserve Order - Also known as iceberg orders, reserve orders are basically limit orders that allow you to hide your position size from other traders. The reason for doing this is to keep other traders from piggybacking on your orders and profiting off of your move which in turn could make it more difficult for you to profit. These types of orders are mostly executed by traders and investors with more money than the average just in their accounts. Reserve orders are mostly used by professionals such as mutual fund investors, hedge fund traders, investment bankers, etc. People with accounts under $100K usually don't have to worry about using reserve orders.

    Additionally, the reason they are sometimes called iceberg orders is that actual icebergs are usually only 10% visible above the waterline and the other 90% is under the water. The trader only wants to show a small portion of their order.

    Reserve/Iceberg orders are the equivalent of a poker player keeping his cards close to his chest when playing.

    There you have it. Order types aren't hard to understand and after you place a few orders you will definitely get the hang of it. Market orders are good for long term investors and limit orders are best suited for short term trades i.e. daytraders and swing traders.
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  • #2
    Great article. Keep up the good work educating the newcomers!