Introduction and Types of Orders
Before you start trading stocks, it’s a good idea to understand the process of trading. Most buyers in this country are accustomed to retail shopping, where the prices are set beforehand by the seller. The stock market operates more like an auction, in which both buyers and sellers are actively setting the prices at the same time. This section will show you how trading works, the different types of trading orders you can execute, and the different systems that you can use to place your orders.
Both buyers and sellers actively set prices in the stock market. Not surprisingly, then, there are two prices associated with every stock: the bid price and the ask price. The bid price is the price at which buyers say they will purchase the security; the ask price is the price at which sellers say they will sell the security. The bid and the ask prices are rarely, if ever, the same: generally, the bid is slightly below the ask. The difference between the two is what is known as the spread--this is the amount that is taken by your broker as profit. Specialists, who are in charge of the coordination of the buying and selling of a certain stock, pair bids and asks together to streamline the process and keep the spread small but positive .
Since the bid and ask prices of a stock are in constant fluctuation, you need to be careful about your sales and purchases. The price that you see quoted may or may not be the price at which you actually buy/sell the stock. For instance, you may look on the internet and see that your stock is selling for a certain price and decide that it’s time for you to sell. However, you might also get distracted by something immediately afterwards, so a little bit of time elapses before you can contact your broker to tell him/her to sell your stock. Then your broker has to relay the order down to his/her representatives on the trading floor assuming the stock trades on the NYSE or Amex . By the time your trade is actually executed, the price of the stock might have slipped from what you thought it was, and you’re left with less cash than you had anticipated.
Sound scary? Fortunately, trading does not have to work that way. The good news for you is that you have many options regarding the method of execution for your trades. In the above example, you would have been using what is known as a market order. Market orders definitely have their uses, but you should be aware of all of the following types of trades:
- Market Orders: As mentioned above, you tell your broker to purchase or sell a specified quantity of stock at the prevailing market price. These are often the lowest-commission trades because they involve very little work on the broker’s part.
- Limit Order: You tell your broker to buy a security at or below a specified price, or to sell a security at or above a specified price. This ensures that you will never pay more for the stock than whatever price you set as your “limit.”
- Stop Order: You tell your broker to buy a security at the market price once it reaches a level higher than the current market price. The opposite would be true if you were selling: you would tell your broker to sell your security once it reaches a level below the current market price.
- Fill or Kill: You tell your broker to execute the trade immediately; if the trade is not filled right away then your broker does not execute the order.
- Day Order: You tell your broker to execute the trade by the end of the day; otherwise, he or she does not fill the order.