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Why a Limit Order? -- By: Bill Kraft
Copyright 2010, Makin' Hay, Inc., All Rights Reserved
Bill Kraft
Editor |
Whether knowingly or not, many retail traders enter market
orders to buy stock and that can sometimes be quite dangerous. A
market order to buy simply instructs the broker to buy shares at
whatever the market price may be at the time the order is filled.
Ordinarily, there may be no problem, but every once in a while, there
could be. Witness the following scenario.
Once upon a time a small pharmaceutical company issued a new
release dealing with the effectiveness and use of its' new drug to
treat a specific form of cancer. The news media interpreted the
release as indicating that the drug was a cure for the cancer and used
that as the headline for their stories. A woman who occasionally
bought stock for investment decided that shares of the pharmaceutical
stock would be a good addition to her portfolio and saw that the stock
had been trading around $20 a share and placed an order with her
broker to buy 1000 shares "at the market." Of course, on the news of
a cure for cancer, the stock price rocketed. By the time her order
reached the market and took its place in line of buy orders the stock
price was rising. When her order was filled, the price had increased
four-fold to $80 a share where her order was filled.
The woman had expected to pay around $20 a share, but because
the stock ran so quickly and there were so many orders, it had moved
$60 a share before her market order was filled. That, however, is not
the end of the story. The news media has misinterpreted the company's
press release. In fact, the press release was basically a rehash of
some old news about their confidence of success an early phase review
by the FDA and a belief that the drug could be helpful in the
treatment of (not cure) the specific cancer. The news story was
corrected promptly and the stock fell to $18 a share. All this
happened within a single day. The investor thought she was going to
buy 1000 shares at $20 for an investment of $20,000. Her market order
resulted in her buying those 1000 shares at $80,000 for a total
investment of $80,000. The stock then dropped to $18 and she was
upside down to the tune of $62,000.
I have no idea whether that story is true or not but is the
concept that has convinced me to always use limit orders when buying.
Of course the dramatic price moves in the story are highly unlikely
though certainly not impossible. Nevertheless it would not be so
unusual to see sharp price moves before getting filled, particularly
if the investor phones his order to a broker and the broker delays
even a little in forwarding the order. In any case I opt for better
safe than sorry.
In my own trading, I always buy on a limit order. The limit
order instructs the broker to buy, but at no more than a specified
price per share. So in our example above, had the lady placed a buy
limit order to buy 1000 shares at a limit of $21, she simply would not
have been filled on the run-up since the price was already higher than
her limit of $21.
There are many orders available to traders and knowledge of
their purpose and use can be extremely advantageous to traders. In my
book, "Trade Your Way to Wealth" for example, I discuss seven
different orders and explain their use in detail. Using orders to your
advantage can definitely improve one's trading and make it easier as
well.
Good Trading!
Bill Kraft
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Bill Kraft
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Good Trading!
Bill Kraft
Editor of $10 Trader, Option Trader and Trend Trader
"Trade Your Way to Wealth" by Bill Kraft is an Amazon.com best seller!
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Exar Corp. (EXAR)
This former high flyer may be worth watching to see if it
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Good Trading!
Bill Kraft
Editor of $10 Trader, Option Trader and Trend Trader
"Trade Your Way to Wealth" by Bill Kraft is an Amazon.com best seller!
"Smart Investors Money Machine" is Bill Kraft's most recent publication.
"Trading for Keeps: Making Money with Low Risk Option Trades" a trading DVD by Bill Kraft
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