You will find it easier to transact in the stock market once you attain a basic understanding of market mechanics. Before a share is purchased or sold, the investor must instruct his broker about the order. This means clearly specifying how the order is to be placed. Sending proper instructions to your broker – either by phone or online- is the first step to avoid hassles later on.
Basically, two types of share transaction exist -buy orders and sell orders. Technically sell orders can be further classified as either selling long or selling short.
Buy orders are placed when you anticipates a rise in prices. The investor enters a buy order when he finds the price appropriate, after deciding the number of shares he wants to purchase and ensuring that he has the requisite funds to take delivery, if needed.
When you wish to sell shares of a company you own at present, either because the investment target has been met or you expect a decline in price, you place a sell order with your broker.
Various types of orders that you can put through to exchanges are as follows:
Price Limit Orders
An investor can have his order executed either at the best prevailing price on the exchange or at a pre-determined price.
A market order is one you place to sell shares at the prevailing price, when your order is entered in the system. They are executed as fast as possible at the best prevailing price on the exchange. It means that your order quantity will be executed the moment it reaches the exchange provided the required quantity is available. This order type is accepted by both the exchanges i.e. BSE and NSE.
The obvious advantage of a market order is the speed with which it is executed. The disadvantage is that the investor does not know the exact execution price until after the execution. This advantage is potentially most troublesome when dealing in either very inactive or very volatile securities.
Limit type orders refer to a buy or sell order with a price limit. Limit orders overcome the disadvantage of the market order, namely not knowing in advance the price at which the transaction will take place. It means that if the order gets executed, them it will be within the limit specified or at a better rate than that. This order type is accepted by both the exchanges i.e. BSE and NSE.
When using a limit order, the investor specifies in advance the limit price at which he wants the transaction to be carried out. It is always understood that the price limitation includes an "or better" instruction. In the case of a limit order to buy, the investor specifies the maximum price he will pay for the share; the order can be carried out only at the limit price or lower. In the case of a limit order to sell, the investor specifies the minimum price he will accept for the share; the order can be carried out only at the limit price or higher.
Use of Market and Limit order
When do you use a limit order? To safeguard against extreme volatility, you can put a limit on the price at which you want your order to be executed. Generally, limit orders are placed "away from the market." This means that the limit price is somewhat removed from the prevailing price (generally, above the prevailing price in the case of a limit order to sell, and below the prevailing price in the case of a limit order to buy).
Obviously, the investor believes his limit price will be executed during the trading day. That, however, is also the chief disadvantage of a limit order. It may never be executed at all. If the limit price is set very close to the prevailing price, there is little advantage over the market order. Moreover, if the limit is considerably removed from the market, the price may never reach the limit – even because of a fractional difference. Also because limit orders are filled on a first come first basis, it is possible that so many of them are in ahead of the investor’s limit at a given price that his order will never be executed. Thus, selecting a proper limit price is a delicate exercise.
On the other hand a market order is filled at the best possible price as soon as an investor places the order and it will not be even possible to cancel the order. However, a limit order may be cancelled or modified at any time prior to execution.
Various types of specific orders
So far orders have been classified by type of transaction (buy or sell) and by price (market or limit). Now differences stemming from the time limit placed on the order will be examined. Orders can be for either a day or until canceled.
Day Order or End of Day Order
A day order is one that remains active only for the normal trading time on that day. Unless otherwise requested by the investor, all orders are treated as day orders only. Market orders are almost day orders because they do not specify a particular price. One key rationale for the day order is that market conditions might change overnight, and thus a seemingly good investment decision one day might seem considerably less desirable the following day.
Special Types of Orders
Stop Loss Order
A stop loss order allows investor to place an order which gets activated only when the last traded price of the share is reached or crosses a predefined threshold price also called as trigger price. It means that if investor feels that any particular share will be worth buy or sell only after it crosses some threshold rate then this type of order gets activated. For example, a buy order at Rs 100 with a stop loss of Rs 90, will mean that if the share falls to Rs 90, the shares will be sold, limiting the loss to Rs 10.
Several possible dangers are inherent when using this type of order. First, if the stop is placed too close to the market, the investor might have his position closed out because of a minor price fluctuation, even though his idea will prove correct in the long run. On the order hand, if the stop is too far away from the market, the stop order serves no purpose.
Further classification of this type of orders can be defined depending upon the price limit of orders, i.e. the price on which the order should execute, as explained under:
Stop Loss Market Order
A stop loss market order is a special type of limit order. A stop loss market order to sell is treated as a market order when the stop price or a price below is "touched" (reached); a stop market order to buy is treated as a market order when the stop price or a price above it is reached. Thus, stop market order to sell is set at a price below the current market price, and a stop order to buy is set at a price above the current market price.
The possible inherent danger associated with this type of order is that because they become market orders after the proper price level has been reached, the actual transaction could take place some distance away from the price the investor had in mind when he placed the order. The reason may be prior queuing up of other orders or order quantity not being available.
Stop Loss Limit Order
The stop loss limit order overcomes the uncertainty associated with the stop loss market order, of not knowing what price the order will be executed at. The stop limit order gives the investor the advantage of specifying the limit price: the maximum price on which the buy order should filled or minimum price on which the sell order should filled. Therefore, a stop limit order to buy is activated as soon as the stop price or higher is reached, and then an attempt is made to buy at the limit price or lower. Conversely, a stop limit order to sell is activated as soon as the stop price or lower is reached, and then an attempt is made to sell at the limit price or higher.
The danger is that, in a volatile market, the order may not get executed because the difference between the execution limit and the stop price may be too low. However, if things work out as planned, the stop limit order to sell will be very effective.
Disclosed Quantity (DQ) order
The system provides a facility for entering orders with quantity conditions: DQ order allows you to disclose only a part of the order quantity to the market.
Also known as circuit filters or circuit breakers, price bands set the upper and lower limit within which a stock can fluctuate on any given day. A price band for the day is a function of previous trading day’s closing.
Currently the both BSE and NSE has fixed price bands for different securities within which they can move within a day.
Price bands are supposed to prevent extreme price movements, reducing the scope of price manipulation. Price bands do slow things down and make it that much harder for operators wanting to quickly manipulate prices in huge leaps. When there is general euphoria or panic in the market that seems fundamentally unwarranted, price bands give wary investors the benefit of a cooling period.
Operators with access to large funds, shares and time at their disposal, however can manipulate the price bands to their advantage by blocking exit/entry of other investors from a particular counter by placing huge orders. For example when a stock touches the lower circuit in a sharp downtrend, ordinary buyers would wait for the next trading session believing that the stock will be available at a still lower price. As a result, investors wanting to sell the stock won’t find buyers at the lower circuit price but would have to offload at a much lower price due to the volume-led manipulation executed by operator. The operator would thus be able to batter the stock down by a large gap created by his own sell orders.
Much larger volume of the battered stock would then be accumulated by the same operator at a much lower price as panic-stricken ordinary investors would happily exit the stock.