Placing
an Order
When placing a trade, it’s important to
understand the differences between the various dates used and the types of
orders that are available to you.
The Dates –
When investing, you need to know your
starting and finishing times. The date that an order is placed and executed
is called the trade date. It is significant because that’s the date
used as the purchase or sales date when calculating your gain or loss on
Schedule D for IRS tax purposes. The settlement date is when the cash
transaction occurs in your account. Typically, trades are settled within
three days. The trade date tracks the accounting of the transaction, while
the settlement date tracks the cash flow on the transaction. Technology has
made major advancements in transaction processing; hopefully, in the future,
we could see the same day settlement of funds.
The Types of Orders
Benjamin Franklin once
said: “watch the pennies and the dollars will take care of themselves.” That
doesn’t work with the stock market! You need to watch both your pennies and
dollars. Once you make the decision to buy or sell a security, you then need
to focus on the best price for the lowest cost. The type of order you place
is your instruction on how your trade is to be executed. Focus on the moment
and try to maximize your profits. Your order type is tricky and it does
create anxiety. For example, if you place a below market limited order, and
if the price does not hit, you may lose out on a good investment. The same
happens with stop orders. The use of sell stop orders is popular when trying
to protect your profits. There are, however, going to be occasions when the
security drops and the sell order is executed, after which the security
bounces back up in value. Being sold out of a good investment, because of
short-term price fluctuations, can be frustrating and happens if the stop
price is not set properly when using stop orders. There are also no
guarantees that orders will be executed.
Here are the main
choices:
Market Order
– Market orders are instructions to make an immediate trade at the best
available market price. This is the basic and most common type of order.
Time is the critical focus and is more important then price. Market orders
are usually executed because price is secondary. The stock price is set as
the trade is executed. If the stock is liquid you should be fine. There are,
however, many situations where prices change quickly, as with IPO’s, and use
of a market order may be inappropriate. Investors, in 1980, who purchased
Genentech’s IPO using market orders, understand this concept well. The stock
initially traded at $35 per share and quickly rose to approximately $100 per
share. With market orders, you are allowing the marketplace to control your
purchase price, which may or may not be wise.
Limited (Or Better)
Order – This involves placing
price restrictions on the order, and authorizing a transaction to be
executed at a specified price or better. The critical element of the trade
is the price of the security; price is more important than time. The
objective is not to overpay for a stock, or to realize a certain price when
selling. Commission rates can be higher using limited orders.
Stop Order –
A stop order is your instruction to buy
or sell a certain stock if a specified price is reached. Once the specified
price is reached, the stop order converts to a market order and is executed.
There are sell stop orders, which are used to protect one’s capital
and profits if a security drops in value. There are also buy stop orders,
normally used to protect the capital and profits of short sellers. Buy stop
orders are set to purchase shares above the current market price. [Short
sellers borrow shares of stock with the hope of returning them at a lower
price, thus making a profit. If, however, a stock price increases in value,
the short sellers lose. To close their positions or limit their losses, the
short sellers use buy stop orders, to return (buy) the stock that was
borrowed.] Stop orders are popular because your positions do not have to be
constantly monitored.
Trailing Stop Orders – Trailing stop orders are instructions where the activation price of a
stop order is pegged to a moving stock price. With long positions, as the
stock price moves up, the stop order is periodically recalculated and a new
activation price is set, according to your preset parameters. Using trailing
stop orders is a disciplined exit strategy, where you are protecting your
gains and selling as a stock retreats from its peak price. For selling stop
orders, the activation price only moves upward. Conversely, for buy trailing
stop orders, the activation price only decreases.
Stop-Limited Order –
The SEC’s
website defines a stop-limited order as “an order to buy or sell a stock
that combines the features of a stop order and a limit order. Once the stop
price is reached, the stop-limit order becomes a limit order to buy or sell
at a specified price.”
