How to place price limits with your broker on stock transactions
THE stock market's hot. You ring your broker and bark, ``Buy 100 `T' common at the market.'' There's a certain satisfaction that comes with knowing order-placing lingo.Skip to next paragraph
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But more than satisfaction can be derived from knowing the kinds of orders available to you. It's important to avoid confusion, make your trade quickly, and protect it.
The ``at-the-market,'' or ``market,'' order is the most basic and most commonly used order. The above example of a market order tells the broker to buy 100 shares of AT&T common stock as fast as possible at the lowest prevailing price. A sell order at the market should result in the highest obtainable price on AT&T stock when the order hits the exchange floor.
The advantage of an ``at-the-market'' order is quick execution. The disadvantage, albeit slight, is not knowing the exact execution price. If a bunch of buy or sell orders for AT&T arrive on the stock exchange floor just before your order, the price may moved up or down before your order is executed.
A ``limit order'' can offer pricing protection, but it requires some skill to apply. A limit order to buy AT&T allows you to set the top price you're willing to pay for it. A limit order to sell sets the lowest price at which you're willing to sell your stock.
For example, you call your broker and he tells you AT&T is now selling at $20 a share. You don't want to pay more than $20.50 a share. So you place a limit order: ``Buy 100 `T' at 201/2 limit.'' It is understood that, if possible, the trade will be made at less than 201/2 ($20.50).
The skill in placing a limit order, especially on the sell side, is in deciding where to set the limit. Let's say you bought AT&T at $18 a share. You think the stock will rise to $23 but will settle for $4 of profit per share (before commission fees). So you set your sell limit at $22. The trick is not to set your sell price too far from the prevailing price; otherwise it may not get executed within a reasonable period of time.
For instance, the price of AT&T rises to 213/4 ($21.75). Then earnings unexpectedly plummet and the stock price tumbles. Your ``Sell 100 `T' at 22 limit'' order may expire before the stock ever rebounds to your sell price.
That raises another consideration. When placing an order, especially a limit order, you should specify how long you want it to remain in effect.
A ``day order'' is active only for that trading day. Usually, your broker considers all orders ``day orders.''
``Week'' orders remain in effect until the end of the week when the order is placed. A week order placed on Tuesday, for instance, lapses by the end of trading on Friday. Similarly, ``month'' orders expire the end of the last trading day in the month the order is placed.
An order with no expiration date is an ``open'' order, often called a ``GTC,'' or ``good-till-canceled'' order. If you use this order, you must be confident that the forces moving this stock will eventually push the market price to your execution price. The danger associated with an open order is that market conditions may change dramatically before you realize it.
For example, investors may suddenly turn bearish on AT&T. As the stock falls, it triggers your limit order to buy AT&T. But whatever turned the market bearish may also change your mind about buying the stock. You call your broker to cancel the limit order, but it's too late; your order has already been executed.
Once you've made a profit, you may want to protect it. Or you may want to place an order that limits potential losses. This is where you'd apply a ``stop'' order.
A stop order is something like the limit order. You might use it to sell if you had bought 100 shares of AT&T at $18 and it's now trading at $28. You think it might go higher, but you want to protect most of that 10-point gain ($1,000 paper profit). So you place a sell stop order somewhere below the current price. Let's say your stop order is at $26. If the price falls to $26 the stop order becomes a market order automatically. Your stock will be sold for about $26 a share. If your 100 shares do sell at
$26, you've salvaged profits of $800 (before commission fees and taxes) in a stock that may have tumbled further.
The beauty of the stop order is that if AT&T falls only to $27, then shoots above $28, you still hold the stock.
The stop order can be a useful tool. ``Unfortunately, most people use it as a substitute for good judgment,'' says John Markese, research director at the American Association of Individual Investors. ``A lot of people put a stop order on and then go off to Tahiti.''
The problems arise from setting the stop price too close to the current price. If the investor isn't aware of how volatile the stock is, or what's happening in the market or the stock's industry, the stop order can be triggered on insignificant fluctuations.
For instance, a stop order might be set to sell AT&T at 273/4 when the current price is 28. In the opening hour of trading, a couple of sell trades could push the stock temporarily lower, touching your stop order price and turning it into a market order. But by day's end or even a few hours later, AT&T could have rebounded back to 28 or above -- only you no longer own the stock.
Another troubling glitch can arise from a jump in prices. You are basking on a South Pacific isle when AT&T soars to 35. But your stop order is still sitting at 273/4. You may lose all of that gain unless you readjust the stop order to bring it closer to the market price.