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Be Smart About How You Trade Stocks

John Waggoner, Senior Associate Editor, Kiplinger's Personal Finance

When you order a hamburger, you could get one that's pink and juicy in the middle, or one that's a blackened hockey puck between two buns. That's why waiters ask you how you want your order. You have several options for ordering stocks as well. Knowing the difference between them can help you get the best price when you trade--and, in some cases, help you avoid losses.

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A market order means you want the order executed as quickly as possible. Market orders can be buy orders or sell orders. In either case, you're simply trading the shares at the current market price. If Microsoft is selling at $140 a share, for example, a market order to buy or sell will probably get you the shares near $140 per share, most of the time.

Investors can use a stop-loss order to limit their losses in a market rout. For example, suppose you had bought 100 shares of Microsoft at $140 and it rises to $155. Congratulations! You're up $1,500. But now you're worried that if the market falls, you could lose that entire $1,500 and more. To mitigate that risk, you can put in a stop-loss order, which tells your broker to sell the stock once the price falls to a certain level, called the stop price--say, $140 in our example. At that point, your stop-loss order becomes a market order, and you'll sell at the next available price at $140 or less. You would lose your gain but probably not your principal.

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Many brokerages will allow you to use a percentage stop order--that is, your order will trigger if the stock falls a certain percentage below its most recent high. (Some call this a trailing stop order.) If Microsoft were at $150, for example, you could put in an order to sell if the stock were to fall 10%, to $135 per share. If Microsoft rose to $160, your trailing stop would still be 10%, but the sell point would rise to $144.

The catch. The problem with market and stop-loss orders is that stocks can sometimes move considerably between the time you give the order to your broker and the time the trade is executed. Suppose you have a stop-loss order for $140. When that's triggered, your broker will sell the stock for its next available bid at $140 or less. In market routs, prices can gap down--meaning that the next bid could be $135, for example, or lower. With a regular stop order, you'll get the next available price, and it might be well below your stop level.

That's where limit orders come in. A limit order allows you to specify the maximum price at which you'll buy a stock and the minimum price at which you'll sell, but note that the order won't be executed unless that price becomes available. A stop-limit order combines the protections of a stop-loss order and a limit order. With a stop-limit order, you can specify the point at which you sell--the stop--as well as the lowest price below the stop that you'll accept, which is the limit. Let's say you had a stop-loss order at $140 for Microsoft. You could add a limit of $138, meaning you'd take any price from $138 to $140. If the stock gaps below that range, you'll have to hold on until the stock hits $138.

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Most discount brokers charge the same commission regardless of order type. And all brokerage orders have a time element. Most are day orders--that is, they are good only for the day you make them. If they can't be filled that day, they expire. For trailing stops or other, more-complex trades, it's best to use a good-till-canceled order, which means pretty much what it says. Good-till-canceled orders don't necessarily last forever. Your brokerage may have a time limit--say, six months--before the good-till-canceled order expires, so be sure to ask about it.

For most long-term investors in a reasonably calm market, a market order is fine. But stop orders can trim your losses in a downturn, and using a limit order to buy can help you snatch bargains once the market has sold off.

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Copyright 2019 The Kiplinger Washington Editors