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Working with Brokers Comments

Kelly Summers   |   October 19, 2007
Ok, let�s suppose you have chosen the right broker. Now let�s examine the way you should work with your broker. You may of course want to let it all take its course, but you know � no pain, no gain! In order to minimize the risk of your investment, it could be much safer to put your trust in the hands of a professional and skillful broker. Thus, you should make your investments by placing orders. There are several kinds of orders. Let�s pick and analyze a few of them.

One of the fastest ways to execute a transaction is by placing a market order. It also offers low commissions due to the minimal work brokers need to do. A market order is when a broker is instructed to execute a transaction immediately at the best market price. Let�s assume for a moment that you are confident that the price of Microsoft stocks will skyrocket. Without wasting your time, you contact your broker and place a market order to purchase Microsoft stocks at the best available current price. It seems like everything is fine, you can go home and relax. However, there is a downfall. At the end, it may turn out that the price of the stock was much higher than you had expected. However, you cannot blame yourself for something you had no control over.

A limit order is more expensive than a market order but it enables investors to control the price of stock they purchase or sell. Limit orders involve transactions at a specified price or better. Such orders are commonly used when trading low-priced stocks, also known as penny stocks and volatile stocks. For example, ABC�s stock is very volatile and you want to make some money by taking advantage of its volatility. All you have to do is to place a limit order to your broker to purchase ABC�s stock at the price not exceeding $1.50 per share. Your broker will execute the transaction as soon as the price of the stock reaches the predetermined level. However, by placing a limit order, an investor accepts the risk of buying a stock that might decline in value.

An average investor understands that trading is a risky venture. Risk minimization is a very critical aspect that any reasonable investor should consider. One approach to minimize risk is offered by a stop-loss order. A stop-loss order is defined as an order placed to a broker with intention of closing an open position at a specified price. It reduces your losses to the level you are willing to accept. If you purchased ABC�s stock at $50 per share expecting it would go up in value, but shortly after, you noticed the trend for decline, you may want to place a stop-loss order to the level of $45. As soon as the stock price reaches that level, broker will sell off your shares immediately. If the price of ABC�s stock continues to decline you will only end up losing $5 per share. However, it is essential to set the right limits when placing a stop-loss order. Setting a stop too far makes it inefficient, and placing it too close reduces efficiency of trade by creating frequent precedents for closing a position.

A stop-loss order is executed when the stock price reaches a preset level. A limit order is executed at the best available price or better. An investor is much better off combining these two orders into one, so called a limit stop-order. A limit stop-order is executed at the best available current price or better, but only after it reaches a certain price level (stop-price).

For example, if ABC�s stock is selling at $50 per share and you are hoping the price would further increase, you can place a limit stop-order, i.e. a stop at $55 and a limit at $60. Your order will be executed when the stock price reaches $55 per share. This way your total transaction costs will not exceed more than $60. However, you should consider the fact that some brokers do not accept limit stop-orders for certain types of securities like penny stocks.

If you want your orders keep pace with market fluctuation, then you would be better off using atrailing stop-order. A trailing stop-order is an order which adjusts the stop-price in response to changes of the market price at a certain percentage rate. In other words, a trailing stop-order for sale automatically raises your stop-price if the market grows but does not lower it if the market falls. And vice versa, a buy order lowers your stop-price if the market price rises but does not increase it if the market goes down. A trailing stop-order is especially useful at the time when the price of stock is continuously taking one direction. Some investors use it when they don�t have opportunity to closely watch the market. However, when the stock price reaches the trailing-stop level, the order becomes a regular market order involving a corresponding risk.

Finally, there is an alternative order, a buy or sell order that allows several alternatives to be used to fill the order. When part of the order is executed, the unused alternatives will be cancelled. For example, an investor may be willing to purchase 100 shares of stock at $20, but he or she may only post an initial bid of 25 shares at $19. The broker may be given some discretion in this matter.

In addition to understanding these orders, you should also consider the time of order execution. The following are the three types of orders which are executed at a specified time:

A day order - a buy or sell order that expires at the end of the trading day on which it was entered unless already executed or cancelled during the day;

An FOK order � a buy or sell order, which if not executed immediately, is cancelled;

A good-till-cancelled order � a buy or sell order that remains open at a specified price until it is executed, cancelled by the client, or expires after a specified period.

You should understand that the most important aspects of investment are closing a position in time and defining a suitable time for opening. Therefore, choosing the right order is very essential. If you are a beginner in the field of investment, make sure you paper trade first! Learn how accurate and prompt your orders are and rely on experts!
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