Stock Market 101 Part 3
Hey There! Part 3 of the guide is here. In this portion we are going to learn about how to buy and sell stocks and the types of orders that we can submit to our broker. You can read Part 1 and Part 2 here.
Buying and Selling Shares.
Buy shares: let’s assume that you want to buy shares of ABC Inc, in order to do this you will go to your broker and instruct them to buy shares for you, how many share? You can buy as little as 1 share, and as many as you can afford. Your broker will do its best to find the number of shares that you want for the price that you specified.
Sell shares: ABC Inc had a great run and you want to take profit, therefore you instruct your broker to sell shares that you own of ABC Inc for the price that you tell them.
I made an emphasis on owning the shares because you can also short sell a stock. This is when you believe that the stock will go down and you want to profit from this, in order to to do this you instruct your broker to short sell the shares.
What happens when you short sells is that your broker borrows shares for you, this means that you don’t own the shares, if the price of the share goes down, you will have to buy the shares or cover the short sell and you will profit the difference from the sell and buy order.
So, in recap, if you expect the stock to go up (Bull mode) you will buy the shares, and when the price go up, you will sell them for a profit. If you expect the stock to go down (Bear mode) you will short the shares (borrow the shares) and will buy them back (cover the short) when the price goes down.
Short selling can be very rewarding if executed properly, but I advise this technique to more seasoned investors, and the reason I mean this is because when you own the shares, you have a limited amount of money that you can lose, which is the stock going from $5 to $0, but, if you borrow the shares (short), you can lose a lot of money, the stock can go up to $10, $20, $100! And you will have to pay the difference to your broker.
Types of Stock Market Orders
When you decide that you want to buy or sell shares, there are many types of orders that you can do:
A limit order is a type of order where we specifies the quantity of shares and the price that it’s willing to pay for. This is the type of order that we recommend
Buy Limit order: You want to buy shares of ABC Inc which currently trades for $5.00 per share, you specify that you want to buy 1000 shares of the stock ABC for $4.95 the share or better. The order will only get executed if the share price is $4.95 or lower. The benefit of this is that you will only buy shares at the specified price, if the price never reaches $4.95 or lower, the order will not get executed and you will not get any shares.
Sell Limit order: You want to sell shares of ABC which currently trades for $5.00 per share, you specify that you want to sell 1000 shares of the stock ABC for $5.05 the share or better. The order will only get executed if the share price is $5.05 or higher. The benefit of this is that you will only sell shares at the specified price, if the price never reaches $5.05 or lower, the order will not get executed
A market order is a type of order where the investor buys or sells a stock at the best price available on the market.
You don’t have any saying on Market Orders and you are left at the mercy of the market. If you want to buy ABC Inc shares that are trading at $5.00 and during the time it took you to fill the order detail and click the buy/sell button the price went up to $6.00 for a brief second, your order will get executed at $6.00, seconds later the price might correct itself back to $5.00. Since you were at the mercy of the market, you overpaid for the stock
The same can happen on the sell side, you might want to sell the ABC stock for $5.00 but suddenly the share price drops to $4.00, in this case, you might end up walking away with a loss
The only time where we suggest to execute a market order is when you need to get out from a trade when the deal is going south really fast, and still in this case, a limit order would be advisable since you will not be at the mercy of the market makers
The next most popular of order type is the stop order, I’m not a fan of stop order, I prefer to stick to Limit Orders, but, a good investing guide needs to talk about stop orders, so by all means, join me on the stop order explanation, it might be a little be thick. Believe me when I say to you that it took me a while to understand the difference between Stop and Stop Limit.
Stop order is an order to buy or sell a stock when the share reaches a certain price, this condition is known as the stop price, once the stop condition is reached, the order turns automatically into a Market Order (please read above). This type of order is generally used to protect your profits or to limit losses when you can’t follow the stock market.
Example: You own shares of ABC at $5.00 the share, if you currently don’t have time or access to track your investment and based on your plan you want to sell the stock automatically if it trades at $4.00 in order to limit your loss. In this case you submit a Sell Stop Order with a Stop at $4.00 and in the event that the share price drops to $4.00 or less, it will automatically sell your shares at the best price available on the market
Note: Stop orders are not allowed on Canadian Exchanges (TSX, TSXV or, CSE)
A stop limit order is an order to buy or sell a stock at a set price or better when the stop price is reached. The main difference with a Stop Order, is that when you specified stop gets triggered, your order will be changed into a Limit Order instead of a Market Order, this gives you more control on how much are you willing to buy or sell your shares.
Example: You own shares of ABC at $5.00 the share, ABC had a great performance and is currently trading at $6.50, since you want to protect your profits, you send a Sell Stop Limit Order with a stop at $6.00 and a limit of $5.80. In the event that ABC share price reach $6.00, your order will change into a Sell Limit Order for $5.80 and your order will only get filled if the market has shares available for $5.80 or more.
Difference between a Stop and a Stop Limit order
Stop and Stop Limit orders looks like pretty much the same, but let’s assume the scenario where ABC share price flash crash from $6.50 to $4.00 and minutes later jumps back to $5.85 (yes, this can happen!) and you have a stop at $6.00 and a limit of $5.80
Stop Order: As soon as the stop is triggered, your order will get executed at the best price available and that price might be $4.00 per share!
Stop Limit Order: As soon as the stop is triggered, your shares will be available to be sold at $5.80 or better, if suddenly the share price goes below $5.80 (and your order didn’t get executed), your shares will NOT be sold for anything less than $5.80 and you get to keep them. This will protect your investment from flash crashes! But if the price keeps going down you will get stuck with the shares.
Pheeeew! That was A LOT about how to buy and sell a stock, eh? I tried to do my best to explain the differences and show some examples but in the case that you still have some doubts, please leave a comment below!
On the next part, I will show you the basics about Technical Analysis and why I believe that every investor should use this tool. Go to part 4 here