Trader's Basics
Basic Trading Information and Knowledge for beginners.
Trading Techniques and Education
I. Placing orders
How-To guide to make the most of your trades
What's a limit order? What is "buy to cover"?
Getting started in investing can be confusing. Here, we're concerned with just placing order and executing orders in equities - stocks. If you're at this website, you've probably got a basic understanding of the process. However, we've worked in the business for many years and have seen many people place an order and they had no idea how the trades are actually executed - or how they get a certain price.
First and foremost: If you are selling stocks, someone out there has to buy it. I remember quite well one customer who held stock options in their employer and wanted to sell that stock for their tidy little profit. They called and said they saw the price of the stock in the paper (the closing price the day before) at $35.00 and wanted to sell it there. Well, the stock was trading next morning at about $32.00 per share and that person did not understand why he couldn't just have $35.00 like the newspaper said.
When you "execute" a trade; that is, a trade you placed was completed, you are either buying the stock from somebody who was selling it, or selling it to someone who was buying it. This 'someone' could be another individual investor or a broker or a market maker. The point is that when you sell, someone bought your shares. When you buy, someone sold you their shares.
How do you want to trade?
You've got a few options when it comes to trading stocks. Buying and selling are the obvious choices. But there are other ways to trade, too: selling short and buying to cover.
Selling short can be done when you have a margin account with your broker. Essentially, you borrow shares of a particular stock and sell them, hoping that the stock will depreciate in value, leaving the difference between the selling price and eventual repurchase price in your pocket. Buying to cover is the term for that eventual repurchase; it closes out a "short position" in a stock.
But since we're talking about your first trade here, it makes sense to focus on buying stocks. Besides, selling short and buying to cover are more advanced investing topics that we'll cover in a later section.
There are 5 common ways to place an order with most online brokers.
1) Market Order
2) Limit Order
3) Stop Order
4) Stop-Limit Order
5) Trailing Stop-Limit Order
Market Order: A market order is a request to purchase or sell a stock at the current market price. Market orders are pretty much the standard stock purchase order. One thing to keep in mind with a market order is the fact that you don't control how much you pay for your stock purchase or sale; the market does. You WILL get your trade executed, but at whatever price the market will have at that time.
Limit Order: This is an order that executes at a specific price that you set (or better) and can be open for a specific time period. While a limit order will prevent you from buying or selling your stock at a price that you don't want, if the price is way off base, the order will never execute. It's important to note that some brokers charge more for limit orders.
Stop Order: This is a market order that is triggered once your stock reaches a specific target price, the stop price. Stop orders may also be called stop-loss orders, because they help investors put constraints on their losses. In many cases, investors will have purchased a stock at $30, and it is now at $50. They will then place a Stop Order at $45. The trade will not go through - ever - unless that stock drops to $45. Then, and only then, it will be executed as a market order. Basically, this order places a "floor" on your stock price and can protect profits.
Stop-Limit Order : This is identical to the stop order, except for the fact that a limit order is triggered once your stock reaches a specific target price. For instance, you can place a stop-limit order that will trigger just like a stop-order, but will not execute unless you can get a certain price that you set.
Trailing Stop: Basically, this is a stop order based on a percentage change in the market price. The "trailing" means exactly that. The "stop-price" trails along behind the stock. For instance, let's say you hold a $100 stocks with a 10% trailing stop. At $100, the stock would be sold if it drops to $90. However, let's say that the stock runs up to $150. Now, the stock will be sold if it drops to $135 (10% below that highest price). We love, and recommend these types of orders as it not only protects profits, but allows the stop price to move higher if the stock does.
Duration of the order is important!
You will have to check with your broker to see exactly what they offer. However, most brokers always offer either a Day Order or a GT (Good 'Till) order. A day order is good for that day, and that day only. If the order is not executed before the end of the day, you will have to enter it again for the next day. A GT30 order is a "Good 'Till 30 Days" order. When you place that order, it will be good and in the system for up to 30 days, unless cancelled. After 30 days, if not executed, it is cancelled. Some will offer a GT orders "'Till" a specific date. Perhaps you want an order Good 'Till Friday. Most brokers will accommodate that.
If you do not mention the duration to your broker, it will be treated as a day only order
Quantity
You will need to specify the total number of stocks that you want to buy or sell. Stocks are usually traded in "round lots" (multiple of 100 stocks, for example).
With a few exceptions, a round lot represents:
- 100 stocks if the stock price is $1.00 or higher
- 500 stocks if the price is $0.10 to $0.99 each
- 1,000 stocks if the price is lower than $0.10 each
An "odd lot" is acceptable on the trading floor, but it is more difficult to trade, unless it is an "at market" order with a significant volume of the security. In many cases, you will receive a slightly lower price for a sale because of the uneven quantity.
II. Shorting stocks
How to open and close short positions.
How and why to short stocks?
You own 10 shares of company ABC at $50 per share. You believe the stock price of ABC is grossly overvalued and is going to crash sometime soon. You are so convinced that the stock will crash, you come to me, and ask to borrow my ten shares of ABC and sell them at the current market price for $50. I agree to lend you my shares as long as you pay me back ten shares of ABC at some point in the future. You take the ten borrowed shares, sell them for $500 (10 shares x $50 per share = $500).
The following week, the price of ABC stock falls to $20 per share. You call your broker and tell him to buy 10 shares of ABC stock, at the new price of $20 per share. You pay him the $200 (10 shares x $20 per share = $200). A few days later, you pick up the shares of ABC and bring them by my office. "Here are the ten shares I borrowed," you say as you put them on my desk.
Do you see what happened? You borrowed my shares of ABC, sold them for $500. The following week, when ABC fell to $20 per share, you repurchased those ten shares for $200 and gave them back to me. In the mean time, you pocketed the difference of $300.
The Speculative Nature of Shorting Stock
What if the price of ABC stock had risen? The person shorting stock would have had to buy back the shares at the new, higher price, and absorb the loss personally. Unlike regular investing where your losses are limited to the amount of capital you invest (e.g., if you invest $100, you cannot lose more than the $100), shorting stock has no limit to the amount you might ultimately lose. Famed investor Ben Graham told us there is nothing stopping an overpriced stock from becoming more overpriced. In the unlikely event the stock had shot up to $1,000 (which actually happened to shares of Northern Pacific during a short squeeze in 1902), you would have had to purchase ten shares at $1,000 a share for $10,000. Taking into account the $500 you received from selling the shares earlier, you would have lost $9,500 on a $500 investment.
In order to begin shorting stock, you must open a margin account with your brokerage firm. You will be charged interest on the borrowed funds as well as subject to several rules and regulations that govern shorting stock (for example, you cannot short a penny stock, and before you can begin shorting a stock, the last trade must be an uptick or zero-plus tick.) After taking these factors into consideration, you will, hopefully, realize shorting stock is not a financially fattening activity in most cases and comes along with additional risks.
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