A discussion on Stop orders, Limit orders and Market orders

by | Aug 26, 2015 | Podcasts, Stock Market Comments

On the podcast (recorded Wednesday August 26, 2015), Tom, Tim and Casey had a discussion on basics: Stop orders, Limit orders and Market orders.

That is because on Monday morning, August 24, 2015, we saw the Dow Jones Industrial Average trade down more than 1000 points. At that time we saw the S&P 500 also trade down a like amount on a percentage basis.  We also saw many exchange-traded funds (ETF’s) trade down on Monday morning – some moved down thirty percent or more in very early trading.

How could that happen?
To help answer that, let’s walk through a few different types or orders which can be entered on stock exchanges:

Market order: you will be buying or selling your shares at what the current price is right now.
Market at Open: can be entered nearly right up until the market opens. You will get the open price.

Limit order:
Instead of buying or selling “at the market” you identify the price for the trade to happen.
But please understand the order may not happen right away – or ever!

Stop Orders: Two types of stop orders —
Stop order: this becomes activated when the stock or ETF moves through that stop price. THEN it becomes a MARKET order.
Stop Limit Order: also becomes activated when the stock or ETF moves through that stop price. THEN it becomes a LIMIT order. Like all limit orders, the order may not happen right away – or ever! It’s possible to have a stop price at one price, and a limit price at another (Sell stop at $30, limit $29)

Was it stop orders that drove down the market on Monday?
VERY possible, but not the entire reason.
Some ETF’s traded immediately down huge amounts, down 30% or more.

But how useful was that stop order?  When you have “gap down” openings: a stock or ETF closed the day before at $50, you have a stop order at $40 and the stock or ETF opens at $30, your stop order was activated…and became a market order, and your shares were sold at $30.

Now with the “ease” of trading – you can now buy and sell stocks and ETF’s on a smart phone. It has become so easy to place an order on your laptop, iPad, smart phone. It’s really easy to make trading mistakes, or simply miss HOW the order should be entered.

Something additional to consider with ETF’s: The price of an ETF is based on the price of the underlying holdings in the basket. The price gets updated throughout the trading day every 15 seconds. Now some media folks urge listeners NOT to own ETF’s with little volume. But the volume of the holdings IN the basket are what matter most.

We heard claims like “the ETF system is broken” when some of these ETF’s were down 25%, 30% or more on Monday morning.  But the system worked.

If a market order is placed, and all the components in the basket are not currently open for trading, you will get the value of the components which ARE open for trading.  Additionally, if an investor places an order – especially a market order – to sell at or before the market opens, there is something working against them: all the underlying members of the ETF may not have begun trading!


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