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Beginner's Guide to Stock Orders

Before you buy stock, read this.

Editor's note: This is a special excerpt from Ratings' Ultimate Guided Tour of Stock Investing. Other Beginner's Guides cover stock basics, market indices, diversification, financial goals, risk tolerance, growth and income stocks, brokers, " 10 Questions to Ask Your Broker" and " 13 Warnings Before You Invest Your First Dollar."

When you're ready to buy stock, it helps to know that there are several different types of orders you can place and they each work differently. The goal here is to make your money work for you and protect your profits. So which type do you choose?

Market Order

This is the most basic type: A market order tells your broker to buy or sell a stock at the current market price. It tends to be immediately filled, because it has no limitations or restrictions. A market order to buy is executed at what is known as the

"ask" price, and a market order to sell is executed at what is known as the

"bid" price.

Market orders are guaranteed to fill, but they do not guarantee the price. A rapidly rising, or falling, market can lead to a "fill" price (the price at which the stock was sold or purchased) substantially different than what you expected when you entered the market order.

Limit Order

If you want to make sure to control any losses, you put in a limit order. As the name implies, a limit order sets a restriction on the purchase or selling price: A "buy" limit order sets the maximum amount you are willing to pay for the named stock; a "sell" limit order sets the minimum price you will take to sell a stock.

For example, suppose a broker recommends that you place a buy limit order at $5 on Company A's stock. This means that you'll only buy the stock if you can purchase it for $5 or less. If the price is (and stays) above $5, the order will not get filled. When you go to buy a car or a home, eventually you arrive at a price that you think is fair and which you will not pay more than. That's essentially a limit order. You might offer to pay $25,000 for a car, but no more. The dealership then can either fill your offer at (or below) the price, or not fill the order at all.

Using limit orders is a great way to buy a stock at a fair price. On the other end of the process, sell limits are a great way to try to lock in a higher profit rather than simply exiting at whatever price the market offers. The one downside to a limit order is that your order might not be executed if the target price is never reached.

Day Order

Another way to buy or sell stock is using the day order, which is an order that's good only for today. Using a day order will sometimes gain some extra leverage, because the brokerage house knows they only have today to get this order filled. A day limit order demands a fair price today, or the brokerage house risks losing this order. If you don't get your day order filled, you have to place a new day limit order the next day and again the following day until your order is executed. If you place this order after market hours, it's good through the close of trading the next day.

Good Till Canceled

With this type of order, your order remains in effect until either it is executed or you cancel it. The order will automatically execute when the stock price reaches its target stated in your limit order. For example, if you have a "good till canceled" order to sell Company X when it hits $120 a share, the order will execute automatically when the price reaches that point. Once a "good till canceled" order is placed, you must expressly cancel it if you wish to change something about the order. Not all brokerage firms will support "good till canceled" orders, and each has its own limits on how long it will maintain such an order. Check with your broker for details.

Stop-Loss Order

This type of order is a sell order, which means you tell your broker to sell your stock if the price drops below a specified price. Most of the time, you put in this type of order to protect the profits already earned on a stock.

Survival Tip: Stay Invested Longer

Economic cycles last at least five years. Staying invested over several economic cycles increases your chances of long-term growth. Also,

diversifying across other

asset classes, like cash and

bonds, helps to reduce your risk to the stock market (see "

Beginner's Guide to Diversification and "

Allocate Your Assets Like a Pro").

This article was written by a staff member of Ratings.