When you buy a stock or ETF you have several choices to choose from for your order type. Market Order, Limit Order, Stop Order or Stop Limit Order. Not knowing the difference or how to use these different types of orders can cost you. 
Although the image shows the options available to those with Vanguard as their broker, all other brokers will give you these same choices. What is the difference in these types of orders?
Market Order
A market order is the simplest of the order types. By selecting market order you simply buy or sell at the best current available price. You can generally get a good idea what that price will be based on the bid-ask spread.
The Bid-Ask spread tells investors two things; the best available price to buy (The Ask) and the best available price to sell (the Bid).
Using the screenshot above, the current ask is $82.42. This means that someone has put in an order to sell their shares for $82.42. If you are willing to pay $82.42 per share, the shares are yours. Therefore, by submitting a market order, you are saying to “Buy at the best price available”. A market order submitted at this time should execute at $82.42. However there are a few conditions that may prevent that from happening.
– First, by the time you hit the button to submit your order someone else may have bought those shares. If no one else has orders in to sell shares at $82.42, you will buy at the next best price (hopefully just a cent or two higher – but that depends on the security and its liquidity).
– Second, if you are buying more shares than are available at $82.42, you may have to buy the rest of the shares at the next best price. For example, if you are trying to buy 2000 shares and there are only 1000 being offered at $82.42, you will be able to buy 1000 shares at $82.42, but the remaining 1000 shares will be bought at the next best price.
There are several risks to market orders.
- If the security you are trying to buy is changing prices very rapidly, you may pay a much higher price per share than what you originally thought. At very volatile times in the stock market, prices may be changing very rapidly and the price you see may have changed significantly by the time you submit your order. This should not be a problem in ordinary times or for securities with high volume (in other words, are liquid).
- If you submit a market order after hours when the stock market is not open for trading, the security you are trying to purchase may change price drastically by the time the market opens.
I am typing this article up at about 6pm, the quote you see above, $82.41, is the price the security last traded for at 4pm before the market closed. If I submit a market order tonight to buy shares, it is highly unlikely that the security will begin trading at exactly $82.41 the next morning. As news happens overnight, investors may become more bullish and want to buy (and therefore be willing to pay more) in the morning or bad news may come out and investors may not buy unless the price falls. Under normal circumstances you should not be affected by these small changes, but it is a risk you take by submitting a market order.
Limit Order
A limit order is used for buy or sell orders. Limit orders allow for investor to set a maximum purchase price or minimum sell price for their shares.
Buy Limit Order
A buy limit order is used to set the maximum price you are willing to pay for the shares.
Using the same example above, you may submit a limit order for $82.00. This would mean that the maximum price you are willing to pay is $82.00 per share. If the security never drops down from $82.41 to $82.00, you will not purchase any shares.
This type of order gives investors a little more safety from potential market volatility, as it sets a maximum price you are willing to pay.
For a buy limit order, the limit price set should be at or lower than the current market price.
Sell Limit Order
A sell limit order is used to set the minimum price you are willing to sell the shares for. With this order you already own the shares.
In the example above, you may set a sell limit order of $84.00 per share. This means that your shares will not be sold for any price under $84.00. If the security never rises to $84.00, you will never sell your shares.
For a sell limit order, the limit price should be at or above the current market price.
However limit order type also has some risks for investors:
- The shares available at your limit price may not be sufficient to satisfy your whole order. If you set a buy limit order for 2000 shares at $82.00 and the security briefly drops down to $82.00, there may not be 2000 shares available at that price. If only 1000 shares are available at $82.00 before the price rises higher, you will only purchase 1000 unless more shares become available.
Stop Order
A stop order is used for buying or selling shares. A buy stop order allows investors to buy only if a security rises to a certain price. A sell stop order allows for investors to set up a way to limit losses on a particular security by automatically selling at a certain price.
A Buy Stop Order
A buy stop order triggers a market order to buy once a certain price is achieved.
For example, an investor may be interested in a particular stock whose shares are declining, but they are worried about buying now and having the share price continue to decline.
Using the example above, let’s say an investor wants to buy shares of the security, but only if it goes above $83.00 per share. In this case, and investor could set a Buy Stop Order at $83.00.
Once the share price reaches $83.00 (or any price above $83.00), a buy market order is executed.
For a buy stop order – always set the stop price at or above the current market price.
Sell Stop Order
A sell stop order is submitted AFTER you have already purchased shares of a particular security.
Let’s say you purchase the selected security shown above for $82.41 per share, but you are worried the share price may drop and you can’t handle the potential losses. You can set a Sell Stop Order to automatically sell your shares at a lower price if that price is reached.
For example, if you want to have your shares sold if the security reaches $81.00, you would submit a sell stop order at $81.00.
If the shares never decline down to $81.00 you will continue to hold your shares.
For a sell stop order—always set the stop price below the current market price.
But be warned, there are several situations where your stop order may not execute at the price you had set. In fact it is possible for the price to execute much lower (for a sell stop order) or much higher (for a buy stop order)!
- In times of terrible news or events, the price of the security may drop significantly very fast. If this occurs, there may be no investors willing to purchase the shares at your stop price. In this case, your stop order will execute at the next available price. If the price per share drops instantly to $80.00, even if you have a sell stop order at $81.00, you will sell your shares for $80.00.
- The same thing can happen under a buy stop order if the price of a security gaps up significantly. If your buy stop order is at $83.00, but the share price gaps up to $85.00, you will purchase the shares at $85.00.
Effectively what happens is when your Stop price (or anything above or below it depending on if it is a buy or sell order) is reached, a market buy/sell order is triggered. Recall our definition above of a market order – this means that you buy/sell at the best available price. A stop order is not a guarantee to buy or sell at that price!
Stop Limit Order
A stop limit order is the combination of all the above order types and can be used to buy or sell a security.
Buy Stop Limit Order
A buy stop limit order is set to trigger a purchase if the shares reach a certain price, but your purchase price is limited based on your set limit.
Continuing on with our example. If you set a Buy stop limit order at $83.00, but a limit price of $83.50, you will execute a buy order if the share price rises above $83.00 but stays below $83.50. If the price gaps up to $84.00 per share, you will not purchase any shares until the price drops to $83.50 or under.
For a buy stop limit order, the stop price should be set above the current market price and the limit price at or above the stop price.
Sell Stop Limit Order
A sell limit order is set to trigger the sale of shares if a certain price is reached as long as the share price remains above your limit price.
In our example if you set a sell stop limit order with a stop at $82.00 and a limit at $81.50, you will sell your shares if the price drops below $82.00 and remains above $81.50. If the price of the security instantly drops below $81.50, your shares will not be sold until the share price rises back up to $81.50.
For a sell stop limit order, the stop price should be set below the current market price and the limit price at or below the stop price.
Conclusion
It is important for investors to know the difference between the different types of buy and sell orders. Knowledge of these order types can save or make you a lot of money in different scenarios.
