Types of Stock Market Orders

Market Orders

A market order is an order to buy or sell a specified number of a particular stock ASAP. A market order is guaranteed to execute. However, the price at which the order will be executed is not guaranteed. 

This is particularly important to note in a fast moving market. If the market is skyrocketing quickly (e.g. reacting to positive news) or selling off quickly (e.g. a flash crash) there can be a large discrepancy between the market price when you place the market order and the market price when the order executes. 

For example, a trader may place a market order to sell 100 shares of IBM at a moment when the current bid price is $50 a share. But if the market is in a rapid decline, by the time the market order request reaches the broker and is executed, the sale could execute at, say, $48 a share. 

This difference between the price at which the trader expects to execute his trade and the price at which it actually executes is called slippage. 

Limit Orders

A limit order is an order to buy or sell a specified number of a particular stock at a specified price or better. Whereas a market order guarantees execution but not price, a limit order guarantees price but not execution. 

For example, if a trader places a buy limit order to buy 100 shares of IBM at $50, this order would execute once the market ask price is $50 or lower.    

On the other hand, suppose a trader places a sell limit order to sell 100 shares of IBM at $50. In this case the order will execute once the current bid price is $50 or higher.

It is important to note that execution of limit orders is not guaranteed. 

For example, suppose shares in IBM are currently trading at $55 a share. Now suppose that a trader wants to buy IBM shares, but at a lower price, and so, he places a buy limit order to buy 100 shares of IBM at $50. If the market ask price reaches a low of $50.01 - much lower than the previous $55/share - but never reaches $50, the order would never execute. 

Or consider the case of a fast moving market. Suppose that the stock market is in a rapid decline and IBM shares have quickly fallen from $55 a share to $51 a share within the past hour of trading. Assume that a trader wants to sell his 100 shares of IBM, but at a price no lower than $50 a share. He could place a limit order to sell at $50 a share or better, but by the time the trade request is placed, the market price may already be at $48/share and his sale would not have executed. 

Stop Orders

A stop-loss order (or simply stop order) is an order to sell/buy a specified number of a particular stock when the market bid/ask price of the stock reaches a specified level. This specified level is known as the stop price. Once the stop price is reached, the order becomes a market order. Traders use stop-loss orders to try to limit losses on their positions or to lock in profits.

For example, suppose a trader buys 100 shares of IBM at $50. Now suppose that the trader places a sell stop order to sell those shares at a stop price of $45. Then a market order would be placed to sell the trader’s 100 IBM shares at the prevailing market price once the market bid price reaches $45. 

The idea here is to try to limit the trader’s potential losses to $5 a share ($500 total). 

However, this strategy risks the trader being sold out of a position as a result of high volatility only to watch the stock price surge later. 

For example, consider again our case of a trader buying 100 shares of IBM at $50 and then, seeking to minimize potential losses on the position, placing a stop-loss order to sell those shares at a stop price of $45. 

Now suppose that the stock market enters a period of high volatility in which intraday 10% swings in either direction are taking place on a near daily basis.

In this scenario, the market price of IBM shares may hit the stop price of $45 in the morning only to rocket up to $55 in afternoon trading. But the trader would have been sold out of the position in the morning at a loss and would therefore miss out on the potential afternoon gains.

Likewise, a trader may have a position closed out at a loss as a result of a temporary decline in the price of IBM stock in a period of more moderate volatility. The stock price could gradually decline from the purchase price of $50 to the stop loss price of $45 over a period of days/weeks and then gradually appreciate past the purchase price of $50. In this case too, the trader would have had his shares sold once the stop loss price was reached only to miss out on future gains. 

A trader who is short a stock may choose to place a buy stop order in an effort to limit potential losses. 

For example, suppose a trader shorts 100 shares of IBM at $50 on the hypothesis that the price will eventually fall to $45 a share. In this case, the trader may place a buy stop-loss order to buy 100 shares of IBM at $55 a share when the market ask price reaches $55/share in an attempt to limit potential losses on the short position to $5 a share ($500 total). 

Note also that once a stop order becomes a market order at the moment the stop price is reached, the weakness of this type of order (i.e. guaranteed execution but no guaranteed price) comes into play. 

Trailing Stop Orders

A trailing stop order is a stop order in which the trader sets a moving stop price a fixed percentage or dollar amount away from the spot market price. With such an order it is said that the stop price “trails” the market price.

For example, suppose a trader buys 100 shares of IBM at $50. Now suppose that the trader places a sell trailing stop order where the stop price trails the spot market bid price by $5. 

If the bid price for shares in IBM declines to $45, the order automatically becomes a market order to sell the 100 shares of IBM. 

But, unlike in the case of a simple sell stop order, the stop price will “trail” the spot market bid price if the price of a stock in IBM increases. For example, suppose after the trader buys the 100 shares in IBM at $50/share the bid price rises to $60/share. In this case the stop price would move up to $55 ($5 below the new market bid price). 

The advantage of such a sell trailing stop order over an ordinary sell stop order is that it allows the trader to lock in some of the potential gains the stock may make while still having a stop price in place to, in theory (i.e. if the market order executes at a price near the stop price), limit losses. 

Similarly, a short seller may use a buy trailing stop order to allow potential gains to run while, theoretically, limiting losses. 

For example, suppose a trader short-sells 100 shares of IBM at $50, betting that its price will decline. Now suppose that the trader places a buy trailing stop order where the stop price trails the market ask price by $5. 

If the ask price of shares in IBM increases to $55, the order automatically becomes a market order to buy 100 shares of IBM and close out the short position. 

But, unlike in the case of a simple buy stop order, the stop price will “trail” the market ask price if the price of a stock in IBM decreases. For example, suppose after the trader shorts the 100 shares in IBM at $50/share the price decreases to $40/share. In this case the stop price would move down to $45 ($5 above the new market ask price). 

The advantage of such a buy trailing stop order over an ordinary buy stop order is that it allows the short-seller to lock in some of the potential profits to be had from a decline in the price of the stock while still having a stop order in price to, in theory, limit losses. 

Written By: Aiden Singh Published: March 23, 2020