Setting limits on what you pay for stocks can be smart

The majority of orders are done at “market.”  This means that a person buying a stock is able to purchase it at the lowest price that other people are willing to sell it for at that moment – this is referred to as the “ask price.”  A person wanting to sell at market would receive the highest price that another person is willing to pay at that moment – this is referred to as the “bid price.”

During volatile times we feel that it is increasingly important that people set limit orders rather than market orders.  From the buy side, limit orders enable you to choose how much you would be willing to pay for a stock.  If a stock price hits the limit price, your order to purchase the stock would be filled if there are enough sellers at that price.  From the sell side, limit orders enable you to choose how much you want to receive for your shares.  If the share price does not reach that level you are content holding onto your investment.

Some points to consider for your next buy or sell order:

1)  Discipline – limit orders provide the discipline to set prices in advance for orders relating to your investment account.  These orders help reduce the emotional aspect of investing.  The clients we work with appreciate the disciplined approach we use to both buying and selling.

2)  Quarterly Meetings – most of our limit orders are set for no more than 3 months and monitored on an ongoing basis.  At every in-person or phone meeting we discuss all open orders – those orders previously entered but not filled.  At any time it may make sense to cancel or change an existing order or add another, depending on market conditions.

3)  Flexibility – there is no cost to set limit orders or to change them.  If the market is moving in a certain direction, then orders can be modified at any time, provided they have not been filled.

4)  Open Orders – one item we highlight with people is to watch the total of all open buy orders.  If the market declines significantly, and all open buy orders are filled, you should ensure the account has enough cash to cover.  If not, you should consider cancelling some of the open orders.  We recommend increasing your cash weighting during bear markets.

5)  Lump Sum – often when people receive transfers from a pension, inheritance, selling real estate, etc. and there may be the temptation to invest the entire amount immediately.  We encourage people that are new to investing to take things very slowly.  Limit orders allow the process to be slowed down and to ease into the market over various cycles.

6)  Limit Orders Within Sector – one strategy that has worked well for investors looking at three stocks in one sector is to prioritize the three by preference.  Stock A is your first pick, Stock B is your second pick, and Stock C is your third pick.  Consider purchasing Stock A at market, enter a limit order to purchase Stock B at 5 per cent below its current market price, and enter a limit order for Stock C at 10 per cent below the current market price.  If the market goes up, you own Stock A only.  If the market declines further then you could possibly pick up both Stock B and Stock C at much lower prices.

7)  Sell Discipline – after a buy order is filled then consider a subsequent sell order at your desired profit level.  If you would like to set your target at 20 per cent profit then a stock you have bought for $20 could be entered with a limit sell order to sell the stock if it reaches $24.

8)  Intra-Day Swings – the majority of people see the end of day values for indices and possibly look up the closing prices for the individual investments they own.  Stock price movements have been extreme at times during the past year.  Even within a one day trading session we are seeing large swings in the indices and specific stocks.

9)  Low Volumes – some stocks have very little trading on the exchange.  The finance term for low activity is thinly traded.  It is always riskier entering market orders on thinly traded stocks and the spread between the bid and ask is normally much wider.  Often a better strategy for these types of securities is to set limits on what you would be willing to pay for the stock or what you would be willing to sell it for.  That way, you do not have to worry about the spread or watching an illiquid position continuously.

10)  Changing Position Size – another great use of limit orders is to use them for increasing or decreasing your position size.  Let’s say you have 500 shares of ABC Company that you purchased for $20 per share.  The initial position size is $10,000.  If the share price increases to $25 then the market value of your investment would be worth $12,500.  One strategy may be set a limit order to sell 100 shares at $25.  If the order is filled then your investment would drop down to the $10,000 level (400 shares x $25).   This same investor could have used a more conservative initial approach by purchasing 250 shares at $20 for a half position size of $5,000.  At the same time, a limit buy order could have been entered to purchase another 250 if the share price drops to $18.00 (a 10 per cent decline).  If the price goes up then the investor is making an immediate profit.  If the price goes down then the investor is able to dollar cost average by buying the same number of shares for a lower price.