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Want the Best Trade Deal? Order Wisely

Stock price can vary dramatically depending on the type of purchase specified. Here is a guide to the most common selections.

August 29, 2000|WALTER HAMILTON

If you're an average investor, you probably know the difference between a "market" order and a "limit" order. But can you differentiate between a "stop-loss" and a "stop-limit"? Or a "fill-or-kill" and an "immediate or cancel"?

Buying or selling the right stock at the right time is always an investor's toughest decision. But using the correct type of order can sometimes be just as important.

The right type of order can mean the difference between buying or selling a stock at a fair price and even being able to trade it at all, especially in today's volatile market.

To be sure you're giving yourself every advantage, it's worth brushing up on the basic types of stock orders, as well as the conditions that investors can place on those orders.

There are four types of orders--market, limit, stop-loss and stop-limit--said Bruce MacAlpine, senior vice president of the active-trader unit at Fidelity Brokerage Services. All four can be used to buy or sell a stock.

* Market order: The most basic type of order, a market order simply instructs a broker to buy or sell a stock at the current market price, regardless of what the price is.

The benefit is straightforward: You're guaranteed to acquire or unload the stock whenever you'd like.

But every type of order has a potential downside, and market orders have a steep one: You have no control over the price at which your orders are filled. You could end up selling for much less than you expected, or buying for much more.

In fact, that's just what happened to many investors who bought hot initial public offerings or other fast-moving stocks in the last couple of years. Investors who expected to buy at, say, $30, were shellshocked when they paid $60 or more as enormous demand caused share prices to surge.

* Limit order: To guard against such a scenario, the bulk of investors use limit orders. These are requests to trade at specified prices or better.

Thus, a limit order to buy a stock at $50 guarantees that the investor will pay no more than $50, and perhaps less if a lower price becomes available.

Limit orders comprise about two-thirds of all orders on the Nasdaq Stock Market and New York Stock Exchange. For after-hours trading, most, if not all, brokers require that investors use limit orders.

The risk with limit orders, though, is that a stock suddenly jumps above, or falls below, the limit price and your order doesn't get filled.

Imagine that a piece of good news emerges, such as strong earnings, that immediately pushes a stock from $20 to $21, on its way to $25 by day's end. The $20.25 limit order you'd submitted earlier would go unfilled and you'd miss out on the profit.

To increase the odds of securing a hot stock, some investors set intentionally loose limits. If, for example, a fast-moving stock is trading at $20, an investor might send in a limit order to buy at $21.

* Stop-loss order: This order, also known as a stop order, is an instruction to a broker to buy or sell using a market order once a stock hits a specified price.

For example, an investor could submit a stop order telling a broker to sell his shares if the price of XYZ Corp. falls to $60. The moment it hits $60, or moves through that point, a market order would automatically be triggered and the stock would be sold at the best available price.

Stop orders are popular among some active individual investors, MacAlpine said. Each time they buy a stock they immediately place a stop-loss order at 10% or so below the purchase price.

The goal is to limit the loss on any single stock. Though they're willing to absorb a 10% loss, they want to avoid a bigger hit that would inflict deep damage on their overall portfolios.

But as with regular market orders, the big risk is that the stock is sold at a dramatically lower price than the customer expects. Imagine that after closing at $61 one night, the company uncorks a profit warning and the shares "gap down" to open at $31 the next morning. In other words, there are no trades between $61 and $31.

A market order is triggered by the stop-loss because the shares have "gone through" $60, and the order is filled at the next available price, say $30.

Such instances "invariably take customers by surprise," MacAlpine said.

Despite the name, it's worth noting that stop-loss orders apply in the same way to stocks that are rising. Say an investor wanted to buy XYZ if the price topped $62 and it "gapped up" to $90. His order would be filled at the best price available, say, $91.

* Stop-limit order: This works the same as a stop-loss order, except a limit order is triggered when the stock reaches a certain price rather than a market order.

If the customer had submitted a $60 stop-limit order in the previous example, the order would not have been filled when the shares tumbled from $61 to $31.

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