Basic Stock Order Types: Tools to Enter & Exit the Market

What’s in a stock order? Just about everything. Think of it as your gateway from idea to action. It’s where the rubber meets the road, where you pull the proverbial trigger, where a potential market opportunity gets real. If you’re a trader or self-directed investor, you’ll likely be placing many buy and sell orders over the course of your investing career. So you’ll want to make sure you do it correctly. Ideally, you’ll nail it every time. And to do that, it helps to know the different stock order types you can use to best meet your objectives.

Here’s an overview of the basic stock order types, their variations, and the different situations in which each one might come in handy. There are three basic stock orders:

• Market order
• Stop order 
• Limit order

It’s important to understand the difference between each one and know how to use these stock orders. Not only do they each present a different route toward entering or exiting the market, but knowing which “door” to enter (or exit) can also help prevent you from making certain mistakes that are avoidable and potentially costly.

What is a market order?

A market order allows you to buy or sell shares at the next available price. If you’re placing a market order to buy, you’ll get filled at the next available “ask” or selling price (sometimes called the “offer”). If you’re using it to sell (or sell short), you’ll likely get filled at the next available “bid” or buying price. Typically, you’d use market orders when you need to get in or out of your position quickly. Remember: Market orders are all about immediacy.

Caveat: A market order may be fast and efficient, but that doesn’t necessarily mean your fill price will be favorable—and not necessarily the same price you see on your screen when you hit Send. You’re likely to get filled within a range near your target price—sometimes closer; other times further from your preferred price. This is called slippage, and its severity can depend on several factors.

For example, thinly traded stocks may have wider distances between bid and ask prices, making them susceptible to greater slippage. Similarly, periods of high market volatility (such as during an earnings release or major market event) can cause bids and asks to fluctuate wildly, increasing the likelihood for slippage.

Not all trading situations require market orders. There are other basic order types—namely, stop orders and limit orders—that can help you be more targeted when entering or exiting the markets.

What is a stop order?

The stop order (sometimes called a “stop loss”) allows you to enter or exit a position once it reaches a specific price level. Once your activation price is reached, the stop order turns into a market order, filling at the next available ask price (in the case of a buy-stop order) or next available bid price (in the case of a sell-stop order).

Confused? Here are a few stop order examples:

• Using a buy stop to enter a long position. If you’re looking to buy a stock at a price that’s above the current market price, you might place a buy stop order. For example, suppose stock XYZ is trading at $25, but you want to get long the stock if, and only if, it gets to $25.50. If you place a buy stop order at $25.50, your order won’t be triggered until the stock reaches that price.
  
  If the stock trades at or through that price, your order becomes a market order at that point. There’s no guarantee you’ll get filled at or near $25.50. (This “no-guarantee” caveat is true in each of these examples.)
• Using a buy stop to exit a short position (stop loss). If you have an open short position, you may want to place a buy stop above the current market price. For example, suppose you’re a short seller who sold XYZ at $45 in anticipation that the stock might fall. If your projection is wrong and stock XYZ’s price rises above $45, your position loses money. So you may decide to place a buy stop order (stop loss) at, say, $46.50 to exit the position in case the market goes up by $1.50.
• Using a sell stop to enter a short position. If you’re looking to initiate a short position below the current trading price, then you might use a sell-stop order to enter your short position. For example, say stock XYZ is trading at $25, and you want to get short the stock if it falls to $24.50. You might place a sell-stop order at $24.50 to enter your short position as the stock declines.
• Using a sell stop to exit a long position (stop loss). If you bought shares of stock and are holding an open position, you can place a sell stop below the market price to exit your position should it fall into negative territory. This is your classic stop-loss scenario, and it’s how most investors understand and use stop orders.
  
  Stop orders can be used to enter and exit the markets depending on your objectives and circumstances. But what if you want to buy a stock below its current price or sell above its current price? This is where limit orders can come in handy.

What is a limit order?

The limit order essentially says, “I want to buy or sell a stock at a specific price or better.” (You can also use a limit order to close a position.) Many investors understand the “at a specific price” part but get confused by the “or better” part. Let’s look at some limit order examples to help clear things up:

• What does “or better” mean? Let’s take a step back. Unless a stock is one of those buy-and-hold-forever, leave-it-to-the-grandkids investments, your goal is to buy low and sell high. If you’re looking to buy a stock, then lower is better. If you’re looking to sell a stock, then the higher you can sell it, the better. So how does the limit order line up with this concept?
• Using a buy-limit order to enter a long position. If you’re looking to buy shares below the prevailing price, you’ll likely use a limit order. This means your order may get triggered if the stock trades at or below your target price. If it all works out according to plan, you may get filled at or below the price you requested. Don’t confuse a buy limit with a buy stop. If a stock is trading at $25, and you want to buy at $27.50, then a limit order might immediately trigger a fill at $25 because that price is lower (hence “better”) than $27.50.
• Using a buy-limit order to exit a short position. If you’re holding a short position, you can use a buy limit to exit your position at a profit. This means that the buy-limit order will have to be placed below the current trading price. Remember that short sellers benefit when a stock’s price declines, so placing an order to close out a position at a lower price can be beneficial.
• Using a sell-limit order to enter a short position. If you’re a prospective short seller looking to sell at a price that is higher than the current price, then you might want to enter a sell-limit order. This may allow you to short a stock as its price undergoes an “uptick,” moving against your preferred position. Of course, you’re hoping price declines once your position is in play.
• Using a sell-limit order to exit a long position. If you bought shares of stock and are looking to sell at a higher price, you might consider placing a sell limit. This is your classic “take profit” order. This order seeks to sell a stock at your price target or better, meaning higher.

The bottom line

Because the stock order is typically the very first step you take when placing a live trade, it should be done carefully and accurately. Knowing which stock order types is key when entering and exiting the markets.

If you’re new to the world of self-directed online investing, you might consider practicing in a simulated trading environment like the paperMoney® stock market simulator on the thinkorswim® trading platform.

All investing involves risk, including the possible loss of principal. 

The risk of loss on a short sale is potentially unlimited because there is no limit to the price increase of a security. There is no guarantee the brokerage firm can continue to maintain a short position for an unlimited time period. Your position may be closed out by the firm without regard to your profit or loss.

Want to learn more about basic stock order types? Watch this short video: