Subject 5. Orders

Orders are instructions to trade. They always specify instrument, side (buy or sell), and quantity.

  • Bid price: the highest price that a buyer wants to pay for the instrument. The best bid is the highest bid in the market.
  • Ask price: the lowest price a seller is willing to accept for the instrument. Also called offer price. The best offer is the lowest in the market.
  • Bid-ask spread: the difference between the best bid and the best offer.

Orders usually also provide several other instructions.

Execution Instructions

These indicate how to fill the order.

Market orders are simple buy or sell orders that are to be executed immediately at current market prices. They provide immediate liquidity for someone willing to accept the prevailing market price.

A limit order is an order that sets the maximum or minimum at which you are willing to buy or sell a particular stock. For instance, if you want to buy stock ABC, which is trading at $12, you can set a limit order for $10. This guarantees that you will pay no more than $10 to buy this stock. Once the stock reaches $10 or less, you will automatically buy a predetermined amount of shares. On the other hand, if you own stock ABC and it is trading at $12, you could place a limit order to sell it at $15. This guarantees that the stock will be sold at $15 or more.

The primary advantage of a limit order is that it guarantees that the trade will be made at a particular price; however, it's possible that your order will not be executed at all if the limit price is not reached.

Traders choose order submission strategies on the basis of how quickly they want to trade, the prices they are willing to accept, and the consequences of failing to trade.

Validity Instructions

These indicate when the order may be filled.

A day order (the most common) is a market or limit order that is in force from the time the order is submitted to the end of the day's trading session.

A good-till-canceled order requires a specific canceling order. It can persist indefinitely (although brokers may set some limits, for example, 90 days).

An immediate-or-cancel order (IOC) will be immediately executed or canceled by the exchange. Unlike a fill-or-kill order, IOC orders allow for partial fills.

An order may be specified on the close or on the open, then it is entered in an auction but has no effect otherwise.

Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you place a stop or limit order, you are telling your broker that you don't want the market price (the current price at which a stock is trading), but that you want the stock price to move in a certain direction before your order is executed.

With a stop order, your trade will be executed only when the security you want to buy or sell reaches a particular price (the stop price). Once the stock has reached this price, a stop order essentially becomes a market order and is filled. For instance, if you own stock ABC, which currently trades at $20, and you place a stop order to sell it at $15, your order will only be filled once stock ABC drops below $15. Also known as a "stop-loss order," this allows you to limit your losses. However, this type of order can also be used to guarantee profits. For example, assume that you bought stock XYZ at $10 per share and now the stock is trading at $20 per share. Placing a stop order at $15 will guarantee profits of approximately $5 per share, depending on how quickly the market order can be filled.

Stop orders are particularly advantageous to investors who are unable to monitor their stocks for a period of time, and brokerages may even set these stop orders for no charge.

One disadvantage of the stop order is that the order is not guaranteed to be filled at the preferred price the investor states. Once the stop order has been triggered, it turns into a market order, which is filled at the best possible price. This price may be lower than the price specified by the stop order. Moreover, investors must be conscientious about where they set a stop order. It may be unfavorable if it is activated by a short-term fluctuation in a stock's price. For example, if stock ABC is relatively volatile and fluctuates by 15% on a weekly basis, a stop loss set at 10% below the current price may result in the order being triggered at an inopportune or premature time.

Clearing Instructions

These indicate how to arrange the final settlement of the trade. For example, which entity is responsible for clearing and settling the trade? The broker, the custodian, or the clearing house?

User Contributed Comments 2

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fobucina: Stop Orders - convert to market orders once stop price is reached
Limit Orders - guaranteed that order will be executed at price or better; therefore, possibility of order not being filled
Miqizjg: nice summary fobucina!