Orders & how and when you must use them
Now that you know about investing, asset allocation, stocks, bonds, futures and options and different types of trading, let us look at the different types of orders so that you can put all that learning to use. Before we move to the order types, one has to learn the basics of bid and offer first.
Stock markets work on the principle of auctions where buyers and sellers come with their respective prices and a trade occurs when they meet on a common price. In the above pictures, the left side in blue contains buy orders with their prices known as bids. The right side in red contains sell orders with their prices known as offers.
What happens is as follows: Buyers come in with their set prices and will wait for sellers to come down to their level. Similarly sellers come in with their prices and will wait for buyers to move up to their level. For a trade to occur, one side has to give up. Suppose the buyers want to buy desperately for whatever reasons (maybe they know of a news, maybe an event is coming up and they want the shares), in any case, the buyers are desperate to acquire shares right now because they anticipate a rise in prices that will make it worth it. So they will pull their bids up to entice sellers or simply match it with the available offer and execute a trade. In the above example, if a buyer wishes to buy 25 shares, he can raise his bid to 348-349 in hopes of seller dropping down to his price or simply meet the offer and acquire it at 350.
Similarly if sellers get desperate because they anticipate a bad news, they will drop down their prices to get buyers to meet them or simply take out the bids. At the end, one side wins (the stronger side) and the other loses (the weaker side). If there are lot more buyers than sellers, there will be a competition to acquire shares and if there are lot more sellers than buyers, there will be a competition to dispose off shares. Competition to acquire raises prices and that to dispose causes them to fall.
Now that we know how bids and offers work, let us look at some of the order types. While all orders are divided into buy and sell orders, there are different ways to classify them based on their functions.
Limit orders as the name suggest have a fixed price at which they execute. They will not execute otherwise. For e.g. you put a limit order to buy Amazon at $3350 whereas Amazon is trading at $3,400. This order will now sit amongst the bid executing only when there is an offer for $3,350 or the markets have begun trading below that level. Until then the offer will stay there, canceled by the broker either at the end of the trading day or as per your choice. Similarly a sell limit order will sit in the offers and be executed when bids come to meet up or markets start trading above that level
Advantages of limit orders include perfect execution at your price. If you are in no hurry to execute a trade, a limit order is the perfect order to place. It will ensure you the price you desire and you don’t have to chase the market or hurry to trade. Disadvantage of limit orders include incomplete to no fills. If you place a limit order and the market moves away from you, you will not get filled and miss the move that came. Often times, when markets are moving fast and one wants to exit, they will be unable to do so with limit orders. For e.g. if suddenly markets start falling and you put in a limit order to sell at $3,350 but it is not executed, now markets have moved to $3,300 and you are stuck in a position that won’t exit because of the limit order. However for our investors trying to invest for the long term, a simple limit order is the best way to go. If it is not filled today, we can always try again tomorrow. For traders however, limit orders are not always useful and for them, we have the next type.
Market orders as the name suggests execute right at the market. A buy order will immediately consume the available offers for the required quantity to be bought and a sell order will consume the bids. Let us consider the bid and offer image that we have posted. A market buy order for 100 shares will first execute at 350 for 25 shares, then 354.95 for 50 shares and 355 for the remaining 25 shares. The next available offer will now be at 355 for 125 quantities and the market price of the stock will be the last traded price at 355. It is easy to understand now that market orders are what makes the markets move. Buyers get desperate, place market orders to take out the offers and move the markets up. Similarly if sellers get desperate, they place market orders to take out the bids and move the markets down.
Market orders are executed instantly. That is the biggest advantage. In case the market has begun running, one can enter and exit immediately. It won’t ensure the best prices but it will allow one to enter or exit. When trying to escape from a bus like in the movie Speed, it is better to get injured but live than to stay put and die. Similarly when the market moves violently, it is better to exit at worse prices than to stay put and bear the full brunt. Another advantage of market orders is a fill is guaranteed as long as there are buyers and sellers in the market.
Its disadvantage is that prices will not always be good. So in case of sudden market movements, one may put in a buy order at market but by the time the order reaches the exchange, markets will have moved away leading to a bad fill. There have been cases where a stock is trading at $100, you put in a sell order and it gets filled at $90 or worse. It happens and is not good for profits. However for traders, market orders are their friends and a wonderful ally to have.
Stop loss orders
The best friend of any trader and a must have arsenal for all. A stop loss order functions exactly as the name suggests, it gets you out of a losing trade, thus stopping your loss. In case of a buy order, a stop loss will be a sell order and in case of a short order, a stop loss will be a buy order. Stop losses are placed away from the buy price and sell price and serve a role akin to a circuit breaker in electric boxes. In case the price movement goes against you, a stop loss will take you out. In some cases a stop loss order can serve as entry points as well.
For e.g. you know that Amazon stock has fallen from $3,350 levels several times. So if it crosses over this level, it has a high potential to move up. So you can place a stop loss buy order at $3,370. If the stock crosses this price, the stop loss order will be triggered and you will buy the stock at that price level. You can then place a proper stop loss sell order to protect yourself and your position. It can be a bit confusing but experience will help resolve this issue. So why not try experiencing it yourself by opening an account with We Bull or Robinhood and placing your first order. They also have loads of analytical tools to help you trade better. So go ahead and place your first order. We will be waiting here when you come back.
Stop loss orders come in limit as well as market orders. However limit orders in stop loss is generally not recommended cos they are meant to get you out of the trade and the inherent disadvantage of limit orders is that they do not guarantee execution. For stop loss, it is generally recommended to keep it market orders only.
Amongst these order types, there are various sub types that differ on execution. Let us go in depth to explore.
All or None
All or None (AON) orders are put in to ensure that you get the complete quantity you wish to buy or none at all. Partial fills are not accepted. For e.g. if you put in an AON order to buy 10,000 shares but only 6,000 are being offered, it will not get filled until 10,000 are available in the offers. Once they are offered, the order will be executed. In normal circumstances, the order will be partially executed with 6,000 shares and the remaining will get executed later. AON orders ensure you get the complete fill and are not left hanging.
Immediate or Cancel
Immediate or Cancel (IOC) orders ensure that you are immediately filled (partially or completely) and the rest is cancelled. If not filled, it is still canceled. This is generally used by large institutions who wish to hide their steps. A normal, large buy order will sit in the bids and a large sell order will sit in the offers. Astute market practitioners as well as market makers will be able to spot such a large order sitting there and try to get ahead of it leading to poor prices for the institution. This order type ensures that either the order is executed or canceled but in no way is it sitting on the books for the world to see.
Fill or Kill
Fill or Kill (FOK) is a combination of both AON and IOC. Either the entire quantity is executed immediately or it is canceled. No partial execution allowed. Used by institutions for getting fills at their price without tipping the market about their activities.
Good till Cancel
Good till Cancel (GTC) orders are those that will stay in the market until you choose to cancel them or the timeframe that the broker allows expires. Its counterpart is Day orders which are automatically canceled at the end of the day. GTC orders are for those investors who have a set price in mind at which they would like to acquire the shares but do not wish to actively check the markets every day or login and place an order every day. They can simply place an order at their desired price and forget about it. It will fill anytime the market trades at that price. Usually brokers set a time limit and this does not go on forever. A limit of 30-90 days is provided after which GTC orders are canceled by the broker. It varies from broker to broker.