How to Buy a Stock

Your first stock trade can be intimidating -- not to mention confusing. You've done your stock homework, you think you've found a winner, and now you're ready to put your new brokerage account to good use and start trading -- but you're not quite sure how to "execute" it.

Trade "execution" is just a fancy way of referring to a transaction. To "trade" usually refers to a particular type of investing strategy, so qualifying your use of the term "trade" with the word "execute" lets other investors know that you're talking about a specific transaction.

The actual time it takes to execute your trade can vary from broker to broker and market to market. Generally speaking, trades are, in essence, instant. As a typical investor, you won't notice a particularly perceptible or painful price difference in the time between placing your order and its execution. (The SEC requires that all brokerage firms provide documentation quarterly to the public about the routing of their client orders. These reports are available from the SEC or from your broker.)

When you do place your order, your broker will most likely route your order through their complex trading computer network to get a hold of your shares. In some cases, your order will never leave the broker -- your brokerage firm might want to clear out shares of the company you're buying from its inventory.

You've got a few options when it comes to trading stocks beyond just buying and selling. But there are other ways to trade, too: selling short and buying to cover. Selling short can be done when you have a margin account with your broker. Essentially, you borrow shares of a particular stock and sell them, hoping that the stock will depreciate in value, leaving the difference between the selling price and eventual repurchase price in your pocket. Buying to cover is the term for that eventual repurchase; it closes out a "short position" in a stock.

But since we're talking about your first trade here, it makes sense to focus on buying stocks. Selling short and buying to cover are more advanced investing topics that you'll definitely want to avoid until you're ready.

Stock Order Types

Of course, buying stocks is also a bit more complicated than just one purchase. There are several different methods for going about your purchase, all varying in terms of price, time limit, and more.

Each of these comes with their own sets of pros and cons. You will have to determine which to use based on your own circumstances - whether you've set a strict financial limit for yourself, how risk-averse or risk-taking you plan on being, what your expectations and predictions are for the market, etc.

So, what are your options for buying stock? There are five different types of stock orders that your broker will likely let you use. They are:

  1. Market Order
  2. Limit Order
  3. Stop Order
  4. Stop-Limit Order
  5. Trailing Stop Order

Market Order

A market order is a request to purchase or sell a stock at the current market price. Market orders are pretty much the standard stock purchase order, and as such are usually executed immediately.

One thing to keep in mind with a market order is the fact that you don't control how much you pay for your stock purchase or sale; the market does.

The quickness with which online market orders have developed may have made this less of a risk than it used to be, but the market still moves faster. If you're buying shares of a company that has a lot of activity around it, there may be other trades getting executed ahead of yours. That can change the price, and suddenly you're not paying what you thought you would.

Some people don't have much of an issue with this. For those that do, this shortcoming can be met with a limit order.

Limit Order

This is an order that executes at a specific price that you set (or better) and can be open for a specific time period. A limit order can prevent you from buying or selling your stock at a price that you don't want, potentially helping you avoid a bad decision. If the price is way off base and not in tune with the market, though, the order will never execute. It can be a good decision in a number of ways, but be wary of volatility; what if you set a particularly low limit and it only reached it because the price of the shares was crashing?

It's important to note that some brokers charge more for limit orders. Why? Well, the trade may not go through. No execution means no commission.

Stop Order

This is a market order that is triggered once your stock reaches a specific target price, the stop price. Stop orders may also be called stop-loss orders, because they help investors put constraints on their losses.

Stop-loss orders, when that price is reached, turn into market orders. The target price is hit, and the trade is executed at market value.

Stop-Limit Order

Stop-limit orders are also stop orders, based around waiting for a specific price. However, stop-limit orders become limit orders when the target price is reached as opposed to market orders.

Turning into a limit order can be a good thing for a stop order, avoiding certain risks. Say you don't want to buy shares of a company unless the price falls to $20.00. If the shares fall to $20.00 but then immediately shoot back up, your market order could go through anyway. With the limit order, the trade isn't automatically executed, and won't execute if it goes back above $20.00.

Trailing Stop

Basically, this is a stop order based on a percentage change in the market price as opposed to setting a target price.

When you put an order in to your broker, you can choose how long the order stays open. By default, orders are day orders, meaning that they are valid until the end of the trading day. Good-till-canceled orders remain open until you actually go in and cancel them.

How to Cancel an Order

There might come a time when you put in an order that you decide you don't want to go through with. If the order has not yet been executed, canceling it is usually as simple as selecting the "cancel" option online or calling your broker.

Remember that once the order does go through, if you're not happy with your investment, you can't take it back to the store it came from. So make sure that you seriously consider all of the implications involved in placing a stock order.

Premarket Trading and After-Hours Trading

Making trades outside of usual trading hours isn't really recommended for new investors, as you should get a hang of how buying a stock is usually done first. However, as it's an option for trading that has grown in recent years, it is something worth mentioning.

Trading done before and after usual market hours (9:30am-4:00pm) has some positives - for example, being able to react quicker to news surrounding a company rather than waiting until tomorrow. But the fact that there are simply far fewer people trading during these hours poses a lot of risks. And can cause a lot of volatility. For now, it's best to stick to your usual market hours.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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