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Chapter 12 — HOW TO MAKE A TRADE
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HOW TO MAKE A TRADE

HOW TO MAKE A TRADE

Now that you know a bit more about how to set price targets and when to buy or sell a stock, it’s time to discuss how exactly you make a trade. It’s not as simple as just clicking a “buy” button, but it’s definitely not brain surgery either. To get started, it’s important to know how to appropriately deal with commissions, the differences between a market, limit and stop order and how to place these orders with a broker.

HOW TO MAKE A TRADE

ELEMENTS OF A TRADE TICKER

First of all, to make a trade, you need to pick your transaction type - where you define if you wish to buy, sell, or sell short. It basically defines what you are attempting to do with the stock.

The ticker, or rather, the abbreviated name of the stock that you are purchasing is also present as well as the order type, where you define whether the order is a market, limit or stop order. You can find more on this in a later section.

Quantity, meanwhile, indicates the number of shares of that stock that you wish to trade and will factor into the total cost of your transaction based on the current market value of that stock.

Another important element is the duration where you have the option of choosing a day or good ‘til cancel (GTC). A day order is an order that will only be good during market hours on that specific trading day. If the order is not filled by then, it will not be executed and a new order will be required if you wish to continue with that trade. A GTC order will be good until it is executed or canceled. After placing an order, an investor has the right to cancel that order at any time as long as the trade has not been executed to that point.

COMMISSIONS

Lastly, the commission, as well as the estimated total, are given to you on the trade ticket as well, although the final price will not be determined until the trade is executed.

As mentioned before, commissions are a crucial part of making a trade since they represent a potentially significant cost. For example, if you purchase 10 shares at $50 per share, totaling a $500 investment at an $8 commission, representing 1.6% of the total purchase, this means that your investment will need to increase by 3.2% (double because you pay $16 total for buying and then selling) for you to break even on the purchase.

As such, it is important to try to increase your total purchase in order to decrease the percentage of the purchase the commission represents. 3.2% isn’t bad at the end of the day, but if your price target is a 10% gain, the commission will take away 30% of your profits.

MARKET, LIMIT, AND STOP ORDERS

When making a trade, it is crucial to understand the differences between order types. These three different order types can be quite crucial in your ordering strategy.

Market Orders can be summed up as “I want this stock now” no matter the price. Essentially, it is an order to buy or sell a stock at the best available price. It guarantees execution, but not necessarily at a particular price. As such, traders should use this type of order only when they need to get the trade done now.

A quick but very important note: It is a best practice to avoid executing a market order outside of normal trading hours. For example, if a news story comes out after the market closes after you have placed a market order, the market may react in a very unpredictable way, causing a significant change in price when the market opens the next day. As such, you may pay a price for the stock that is considerably different from what you expected. This potential difference is referred to as a gap in price.

Limit Orders is appropriate when you want a specific price (or better) and guarantees a price but not actual execution. A limit order might make sense if:

  • You are buying and want a lower price since a limit order will let you specify a price under the current market price.

  • You are selling and want a higher price since a limit order will let you specify a price over the current market price.

Stop Orders are orders to buy or sell a stock at a specific price.

As such, a sell stop order is synonymous with damage control. Essentially, with a sell stop order, you identify a precise price that will activate your order to sell the stock which limits the damage if the stock takes a sudden dive. Once triggered, it becomes a market order executed on the next trade.

Additionally, a buy stop order consists of identifying a specific price that will trigger a purchase of the stock, preventing the potential gains from getting away from you.

Quiz

You place a sell limit order of 100 AAPL GTC at a price above the current market price. During that day, the market price never reaches your limit price and the market closes without your trade being executed. What will happen to your sell order the following open market day?

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  • 1
    It will be automatically cancelled when the market opens that day.
  • 2
    It will be executed as a market order since the market never reached the limit price during the previous day .
  • 3
    It will be automatically entered with the same parameters as when it was first input and stay open until it either gets executed or you cancel it.
  • 4
    It will be open during the market open hours. But, unless it was executed, it will be automatically cancelled at the closing of the market that day.
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