Investors must specify how a trade will be performed when they request to buy or sell a security. We’ll discuss four different order types in this chapter:
Market orders
Limit orders
Stop orders
Stop limit orders
Market orders
Market orders, which are appropriate for investors seeking immediate executions, are discussed in this chapter. This order type does not specify a price and goes through at the next available market price. In the real world, market orders typically fill within a few seconds of placing the order.
When a market order is placed, execution is guaranteed, meaning the customer’s transaction request is guaranteed to occur. However, the price is not guaranteed. This presents a risk for a customer, especially if the market order is placed when the market is closed.
Assume an investor places a market order to buy stock in a pharmaceutical company after the market closes when the stock price is $50. A few hours later, a news article about the company curing cancer is published, and the stock price skyrockets to open at $200 the next day. If the investor’s order is still in place at the market open, they will pay 4x the amount they likely expected to pay. Although scenarios like this are relatively rare, it’s common for stock prices to fluctuate overnight.
It could go the other way too. Assuming we’re still discussing our $50 stock, a customer faces some risk if they place a market order to sell when the market is closed. The stock price could fall significantly overnight, resulting in a sale at a much lower price. For this reason, investors generally avoid placing market orders overnight.
When an order is placed, customers must specify the time the order covers. Generally speaking, orders can be day orders or good-til-canceled (GTC). Day orders are canceled at the end of the day if they remain unexecuted. GTC orders are only canceled once the customer requests, which could be days, weeks, or months. Market orders always go through instantly, so broker-dealers automatically default their timeframe to day orders.
Here’s a video that dives further into market orders:
Limit orders
Limit orders exist for customers concerned about prices. Unlike market orders, limit orders guarantee transactions will occur at a specific price or better. However, they do not guarantee execution. Let’s work through a few examples.
The investor wants to purchase 100 shares of ABC stock, but is unwilling to pay more than $50 per share. Once the stock is trading at that price or below, the order executes. The trading tape reflects available prices for the security, in order from left to right. $49.99 is the first price available at $50 or below, so the order will fill at that price.
Investors use limit orders to seek better prices. For example, if the stock’s price is $55, a customer could place a buy limit at $50. If the order executes, they purchase the security for $5 cheaper per share. However, the order will only execute if the price falls.
Let’s see if you can answer a buy limit order question.
Although the word ‘limit’ is not there, it’s assumed to be a limit order if a price is specified and nothing else. This is a sell limit order, where the customer requests a sale of 100 shares of XYZ stock at $70 or higher. Once the stock is trading at that price or above, the order executes. With the trading tape provided, the order fills at $70.01, the first price at $70 or above.
Let’s see if you can answer a sell limit order question.
Sell limit orders fill at the price specified or higher. $30.05 is the first price available that’s $30 or higher.
Here’s a video that dives further into sell limit orders:
Limit orders often take some time for them to execute. Therefore, limit orders can be day orders that cancel at the end of the day if they remain unexecuted, or GTC orders that are canceled when the customer requests.
Stop orders
Stop orders, often called “stop loss” orders, feel a bit “backward.”
When a buy stop order is placed, the investor buys the security when its price rises. When a sell stop order is placed, the investor sells the security when its price falls. Why would an investor want to buy at high prices and sell at low prices? There are a few legitimate reasons.
Let’s assume the following:
Long 100 shares of ABC stock @ $50
Investor places a sell 100 shares of ABC stock @ $45 stop
Sell stop orders trigger when the market price falls to the stop price or below. When the order triggers, also referred to as electing, it begins the process of executing. In this example, the order triggers (elects) when the market price falls to $45 or below. By placing this order, the investor cuts their losses when their stock position loses $5 or more. Essentially, they’ve set a floor beneath themselves.
Long 100 shares of ABC stock @ $50
Investor places a sell 100 shares of ABC stock @ $45 stop
Stop orders do not execute immediately like limit orders. First, the order triggers when the market price falls to $45 or below. This order triggers at $44.99. After the trigger, the order transforms into a market order, which will fill at the next available price. The next available price is $44.97, where the order executes.
Stop orders always involve this two-step process. First, the order triggers, then it becomes a market order that fills at the next available price. Because the end result is a market order, nothing is guaranteed with this order type. Execution isn’t guaranteed because the order only triggers if it falls to $45 or below. Price is not guaranteed because it becomes a market order that will fill at the next available price, regardless of what it is. The execution price could be above, below, or at the stop price.
Let’s see if you understand sell stop orders.
An investor goes long 100 shares of stock @ $80. They place a sell 100 shares @ $78 stop order.
Trading tape: $79… $80… $78.50… $78… $79…
At what price will the order trigger? At what price will the order execute?
(spoiler)
Trigger.= $78
Execute = $79
Sell stop orders trigger when the market price falls to or below the stop price. This order triggers at $78. After the trigger, the order executes at the next available price, which is $79.
Here’s a video that dives further into sell stop orders:
Buy stop orders are also “stop loss” orders for short stock positions. Click the following link if you need a refresher on shorting a security. Investors with short positions utilize buy stops to prevent losses. Let’s look at an example:
Sell short 100 shares of ABC stock @ $80
Investor places a buy 100 shares of ABC stock @ $90 stop
Buy stop orders elect (trigger) when the market price rises to the stop price or above. In this example, the order elects when the market price rises to $90 or above. By placing this order, the investor cuts their losses when their short stock position loses $10 per share or more. Essentially, they’ve established a ceiling above themselves.
Sell short 100 shares of ABC stock @ $80
Investor places a buy 100 shares of ABC stock @ $90 stop
The order triggers when the market price rises to $90 or above, specifically at $90.02. After the trigger, the order transforms into a market order, which fills at the next available price. The next available price is $90.01, where the order executes.
Let’s see if you understand buy stop orders.
An investor goes short 100 shares of stock @ $20. They place a buy 100 shares @ $21 stop order.
At what price will the order trigger? At what price will the order execute?
(spoiler)
Trigger = $21.10
Execute = $20.50
Buy stop orders trigger when the market price rises to or above the stop price. This order triggers at $21.10. After the trigger, the order executes at the next available price, $20.50.
Here’s a video that dives further into buy stop orders:
Like limit orders, stop orders can be day or GTC orders. If placed as a day order, the order is canceled if it remains unexecuted by the end of the day. If placed as a GTC order, the order stays open until executed or canceled by the investor.
Stop limit orders
Stop limit orders are hybrids of limit and stop orders. Essentially, a stop limit order is a stop order that becomes a limit order after it triggers (elects). The only difference between a stop and a stop limit order is what happens after the trigger.
Stop limit orders are used in the same way as stop orders. Typically utilized as a way to prevent losses, stop limit orders are perfect for investors worried about the lack of price guarantee with a normal stop order. Because the order becomes a limit order after the trigger, the investor is guaranteed the price. Let’s take a look at an example:
Long 100 shares of ABC stock @ $30
Investor places a sell 100 shares of ABC stock @ $25 stop $23 limit
To properly approach a sell stop limit order, focus on the stop first. Sell stops trigger when the market falls to or below the stop price ($25). After the trigger, the sell limit kicks in and the order fills as long as the price is at or above the limit price ($23).
Long 100 shares of ABC stock @ $30
Investor places a sell 100 shares of ABC stock @ $25 stop $23 limit
Focusing on the stop first, the order triggers when the market falls to $25 or below. At $24.99, the order triggers and becomes a limit order. Next, the order executes as long as the market price is $23 or higher. At $24.98, the order executes. The limit part of the order ensures that the customer will not sell the stock for anything less than $23 per share.
Let’s see if you understand a sell stop limit.
An investor goes long 100 shares of stock @ $70. They place a sell 100 shares @ $65 stop limit order.
At what price will the order trigger? At what price will the order execute?
(spoiler)
Trigger = $64.90
Execute = $65.05
Sell stop limit orders trigger when the market price falls to or below the stop price. This order triggers at $64.90. After the trigger, the order executes when the market rises to $65 or higher. The order executes at $65.05.
In case you were wondering, both the stop and the limit price are the same when only one price is specified.
Here’s a video that dives further into sell stop limit orders:
Let’s take a look at a buy stop limit order:
Sell short 100 shares of ABC stock @ $70
Investor places a buy 100 shares of ABC stock @ $77 stop limit
Again, we will focus on the stop first. Buy stops trigger when the market price rises to the stop price or higher. After the buy limit kicks in, the order fills as long as the price is at or below the limit price.
Sell short 100 shares of ABC stock @ $70
Investor places a buy 100 shares of ABC stock @ $77 stop limit
Focusing on the stop first, the order triggers when the market price rises to $77 or above. At $77.02, the order triggers and becomes a limit order. Next, the order executes as long as the market price is $77 or lower. At $76.98, the order executes. The limit part of the order ensures the customer does not buy the stock for anything more than $77 per share.
Let’s see if you understand buy stop limit orders.
An investor goes short 100 shares of stock @ $25. They place a buy 100 shares @ $28 stop $29 limit order.
At what price will the order trigger? At what price will the order execute?
(spoiler)
Trigger = $28.01
Execute = $28.09
Buy stop orders trigger when the market price rises to or above the stop price ($28). This order triggers at $28.01. After the trigger, the order executes if the market is at the limit price ($29) or below. The order executes at $28.09.
Here’s a video that dives further into buy stop limit orders:
Just like limits and stops, stop limit orders can be day or GTC. If placed as a day order, the order will be canceled if it doesn’t execute by the end of the day. If placed as a GTC order, the order will stay open until executed or canceled by the investor.
Conclusion
In conclusion, it’s important to remember where the market needs to go for an order to trigger or execute. Many use “SLOBS” and “BLISS” to help them recall how order types work. The following visual is great to memorize and re-write on your scratch paper while taking the Series 66 exam:
As you can see, using this visual can help you remember how these orders work. With sell limits above the line, this tells you they execute when the market price is at or above the limit price. With buy limits below the line, they execute when the market price is at or below the limit price.
Stop orders don’t execute immediately, but they trigger at specific market prices. Utilizing the SLOBS/BLISS visual, sell stops trigger when the market price is at or below the stop price. Buy stops trigger when the market price is at or above the stop price.
In case you were wondering, the ‘O’ in “SLOBS” and the ‘I’ in “BLISS” are only there to make an acronym.
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