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always placed at a different price than that at which the stock is currently trading higher for
sales and lower for buys. This is known as away from the market.
Plain English
Limit orders instruct a broker to purchase stock at a price lower than the current
market price or to sell stock at a price higher than the current market price.
Let's suppose that you want to buy 100 shares of XYZ Company, which at the moment is
trading for $10 per share. You are convinced, because of something you read in the
newspaper, that the price of the stock is about to drop XYZ is being sued for copying ABC
Com-pany's patent, let's say. You are an attorney who knows that ABC Company's case
won't stand up in court. Therefore, you figure that the initial price of $10 per share of XYZ
Company will drop when people get the bad news and then will go up again when people get
the later news that the case has been dismissed. You give your broker a buy limit order.
The buy limit order tells your broker to purchase XYZ Company's stock only when it drops to
a certain price, which in your case is $8. You will also probably want to use a notation to tell
your broker how long you are willing to wait for the price to drop: a day, a week, or a month.
You do this, of course, believing that the value of the stock will eventually go back up. So
your investment strategy is to buy as if the stock is on momentary sale.
On the other hand, if you currently own XYZ stock valued at $8 and you believe its price is
going to go up and then later drop, you will want to give your broker a sell limit order. By
doing so, you tell the broker to sell your stock only if the price rises to $10. Of course, you are
assuming that the price of XYZ stock will later drop and remain below the price of $10. This is
called getting out when the going's good.
CAUTION
Be warned that the type of timing necessary to successfully manipulate limit orders
doesn't come quickly or easily. New investors are strongly urged to consider the
pitfalls in this type of trading before attempting it.
I l@ve RuBoard
I l@ve RuBoard
Stop Orders
The other side of the limit order is the stop order. By using a stop order, an investor limits
fluctuation of the price at which he or she is willing to own the stock. Or, in other words, the
stop order is used to keep an investor from losing money he or she has already made on
long and short positions.
Long:
A long position simply means that an investor owns a share of stock outright and has full
rights as pertain to that ownership.
Short:
A short position means that an investor has sold stock that he or she has borrowed with
the intention of returning the stock by repurchasing it at a later time when the price of
the stock has dropped.
Say, for example, that you have already purchased 10 shares of XYZ Company at the price
of $10. Luckily, the price of XYZ Company has risen since you purchased it to the price of
$20 per share. This is no surprise to you, because you expected the value of the stock to
rise, or you wouldn't have purchased the stock to begin with. The stock you purchased that
was originally worth $100 is now worth $200. Lucky you!
Plain English
Using a stop order, an investor seeks to cover a short position by instructing a
broker to sell stock at a price lower than the current market value or to buy stock at
a price higher than the current market value.
But let's also say that you have a sneaking suspicion that the price of XYZ Company will go
up for a while and then drop. And, different from the limit order example, you believe that
once the price begins to drop, it will not go back up again. You want to protect the $100 profit
you have already made. To do this, you give your broker a sell stop order. By doing this, you
tell your broker, "Should the value of my stock drop below $20 per share, I want you to sell all
my stock automatically."
This way, should your stock drop below $20 and you can't get to a phone to yell "Sell! Sell!"
as they do in the movies, you're already covered; your broker has received standing
instructions from you and should be trying to sell your shares.
You should be aware of three more lines of small print regarding the sell stop order.
1. If you had bought each share of XYZ Company's stock for $10, you obviously couldn't
put a sell stop order on it for $20, since by definition the stock meets that criterion as
soon as you purchase it. To deal with that, most investors give progressively higher sell
stop orders as the price of the stock continues to rise. So, upon purchasing the stock,
you would place a sell stop order with your broker for, let's say, $9. Once the price of the
stock rose to $12, you would place a sell stop order for $11, and so on.
2. If your stock is a volatile one, you could be shooting yourself in the foot without knowing
it. As is often the case with volatile stocks, a stock may drop in the morning but rise later
in the day. For example, should the price of XYZ drop below the sell stop order price in
the morning, your broker will try to sell it. Should the price jump in the afternoon as
everyone notices the price drop and thinks the stock is a bargain, you may lose out on
the price increase because you may no longer own that particular stock, thanks to your
extremely efficient broker.
3. In each of these transactions, remember that service charges would apply, and we've
discussed how these can quickly eat away any or all the profits you may have actually
made with your trading.
A buy stop order is a little more complicated since short positions are involved. Should you
need a refresher, a short position works like this. Say the price of XYZ Company stock is at
$10. You believe the price will go down to $5. A short position will allow you to actually make
money from the decline in the stock price. You would "borrow" 10 shares of XYZ Company
and sell them at the price of $10. When (if) the price did actually drop, you would purchase
10 shares at $5, return them to the market where you borrowed them, and pocket the $50
difference.
A buy stop order would function to keep you from losing money in this transaction too. Say
you have borrowed and sold the stock, and the price drops to $5. You place a buy stop order
with your broker, telling him or her to purchase the 10 shares if the stock price rises to $6.
Although you will make less than in the $5 example, the buy stop order will keep you from
losing even more if the price of the stock continues to rise. The $40 you pocket by
repurchasing the stock at $6 isn't as good as the $50 you would have made by repurchasing
the stock at $5, but it's better than the $30 you would have pocketed had the stock risen to
$7 and you hadn't had the buy stop order.
All three of the small-print examples regarding the sell stop order also apply to the buy sell
order. Successive buy sell orders are required as the price of the stock continues to drop.
Minor fluctuations may animate these orders and keep you from making the same profits you
would have realized had you sat tight. And those darn service charges keep adding up and
adding up.
TIP
Stop orders may possibly limit your ability to make money, but they will definitely
protect you from losing money. For this reason they are particularly popular with
new investors.
The 30-Second Recap
Round lots are the standard number of shares grouped together for trading, usually 100
shares for common stock.
Odd lots refer to trading shares outside of round lots, that is, piecemeal or individually.
Time notation refers to an instruction to your broker as to the time frame within which
each of the following orders must be filled.
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