Stock Order Types Explained: Market vs. Limit Order
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Stock trading plays a key role in financial markets. Publicly traded companies sell stock to pay off debt, launch new products, and expand operations, while investors buy shares to own a piece of a company, exert some influence over the company’s decisions, and, most importantly, attempt to build wealth through capital appreciation and/or dividend payments.
Below, we offer a guide to the fundamentals of stock trading, including types of trading, key strategies, and navigating the regulatory environment.
Key Takeaways
- Stock trading involves buying and selling shares of ownership in companies.
- Different types of trading include day trading, swing trading, and long-term investing.
- Key trading concepts include market orders, limit orders, and risk management strategies.
- Understanding the regulatory environment is crucial for compliance and effective trading.
- Successful trading requires a well-defined plan, continuous learning, and emotional discipline.
Understanding Stocks and Exchanges
What Are Stocks?
Stocks are securities that provide holders a share of ownership in a company. Many investors deal exclusively in common shares, which entitle them to vote in shareholder meetings and receive dividends. Preferred shares are less common, but give holders priority for some payments and distributions in exchange for voting rights.
The Role of Stock Exchanges
In the U.S., stock exchanges are organizations regulated by the Securities and Exchange Commission which facilitate the buying and selling of stocks. The major exchanges in the U.S. include the New York Stock Exchange (NYSE) and the Nasdaq.
Types of Stock Trading
Day Trading
Day trading is the fastest-paced form of stock trading. Day traders buy and sell shares of stocks throughout the day, seeking to benefit from short-term price fluctuations over a period of minutes or even seconds. Most day traders close out their positions before the end of the trading day to avoid overnight risks.
Swing Trading
Swing traders, by contrast, focus on the medium-term. They hold stocks for several days or weeks, attempting to capitalize on the “swings” in a stock’s price as it fluctuates between support and resistance levels.
Long-Term Investing
Long-term investing involves buying securities with the intention of holding them for an extended period of time—typically a year or more. Long-term investors seek companies with strong fundamentals, believing they will appreciate in value over time.
Key Concepts in Stock Trading
Market Orders and Limit Orders
When individual investors buy and sell shares of stocks through an exchange, they typically do so through a brokerage. To facilitate these transactions, investors may use different types of orders, or trading instructions, including market and limit orders.
A market order is an instruction to buy or sell a stock immediately at the best available price. A limit order, by contrast, is an order to buy or sell a stock at a specified price or better (the limit price or lower for a buy and the limit price or higher for a sell).
Investors may choose to use either or both types of orders depending on their goals and trading style.
Technical vs. Fundamental Analysis
Investors evaluate the suitability of stocks for investment using technical and fundamental analysis. Technical analysis evaluates a stock’s price movements over time in an effort to predict future changes, while fundamental analysis focuses on measuring a company’s financial health by considering its balance sheet, income statement, and other financial metrics.
Risk Management
Investors often also take steps in their transactions to manage risk. A stop-loss order, for instance, says to buy or sell a stock only when the price reaches a specified level. Position sizing is another risk management technique that helps determine the appropriate amount of stock to buy or sell based on the trader’s risk tolerance.
Tools and Platforms for Trading
Trading Platforms
Retail investors use trading platforms to execute trades. These platforms typically include company information, real-time quotes, and often fundamental or technical analysis, as well as a system to create orders to buy or sell. Some of the most popular platforms include Robinhood, E*TRADE, and TD Ameritrade.
Technical Analysis Tools
Technical analysis tools include a host of different price charts and indicators such as:
- Relative Strength Index (RSI): Measures the speed and change of price movements.
- Moving Average Convergence Divergence (MACD): A trend-following momentum indicator that shows the relationship between two moving averages of a stock’s price.
Regulatory Environment
FINRA and SEC Regulations
Traders must be aware of regulations from key oversight bodies such as FINRA and the SEC to stay in compliance. These regulations ensure transparency, fairness, and accountability in trading. Pattern day traders—those making at least four day trades within five business days—must maintain minimum equity of $25,000 in their margin account when day trading.
Margin Accounts and Leverage
A margin account is a type of brokerage account that allows traders to borrow funds to increase their buying power. They are a form of leverage, a concept in which an investor increases their purchasing power in exchange for increased risk of larger losses.
Strategies for Successful Trading
Developing a Trading Plan
It is essential to develop a comprehensive trading plan to stand the best chance of capital appreciation. A trading plan should outline goals, strategies, risk tolerance, and criteria for entering or exiting trades. Dollar-cost averaging is a common plan and involves investing equal portions of money at regular intervals in order to avoid trying to time the market.
Staying Informed
While it’s relatively easy to begin to make trades, informed investors know that their learning never stops. Stock traders must continuously stay informed about market conditions, news, and economic events that might affect stock prices. This includes monitoring reports, announcements, and updates related to companies, industries, and global markets.
Challenges and Risks in Stock Trading
Common Pitfalls
New investors often miss out on potential returns (or magnify losses) by succumbing to common pitfalls such as turning over investments too quickly, not fully understanding an order or investment, attempting to time the market, and failing to diversify their holdings.
Psychological Challenges
Investors can easily become emotional and stressed, and these reactions often lead to poor decision-making if not kept in check. Know that the risks of psychological challenges to investing are real and that a solid trading plan can help to avoid them.
This is a time restriction that you can place on different orders. A good-til-canceled order will remain active until you decide to cancel it. Brokerages will typically limit the maximum time you can keep an order open (or active) to 90 days.
If you don’t specify a time frame of expiry through the GTC instruction, then the order will typically be set as a day order. This means that after the end of the trading day, the order will expire. If it isn’t transacted (filled) then you will have to reenter it the following trading day.
Which investment is best for beginners?
Mutual funds and low-cost exchange-traded funds (ETFs) are great choices for beginners. They provide built-in diversification and professional management, making them lower risk compared to individual stocks.
How can one start trading stocks with a limited budget?
Many trading platforms offer commission-free trading or low-cost trades, and investors with limited budgets can start by buying small quantities of low-cost stocks or focusing on fractional shares.
How do geopolitical events affect stock markets?
Geopolitical events can have a significant impact on stock markets, although this is dependent upon many factors including the sector—and even the specific industry or company—as well as the nature of the event. Wars, elections, trade policies, regulation, legislation, and many other such events can impact markets.
What is the golden rule of stock trading?
The golden rule of stock trading is to never risk more than you can afford to lose. Always implement proper risk management techniques and only trade with money you can afford to lose.
The Bottom Line
As you gain more experience with trading, you may find that combining both market and limit orders, as well as the other orders covered above, can help you achieve your investment goals while managing risk effectively. It’s essential to keep learning about various order types and to stay informed about market trends and conditions that may impact your trading decisions. Successful trading requires it.