Someone made a huge mistake last week.
It isn’t the first time it has happened … and it won’t be the last. Avoiding this common mistake could save you thousands of dollars during your investment career.
So, what happened?
Shares of FinTech Acquisition Corp. II (Nasdaq: FNTE) shot up when trading opened on July 19.
You can see the dramatic price move when trading opened on July 19. The box toward the upper left of the image shows an investor bought shares for $11.99 at 9:30 a.m.
Shares immediately returned to near $10, where they had been trading.
That’s an instant loss of more than 15%.
I am confident the culprit of this occurrence was a market order.
I want to tell you why you should avoid market orders when buying (or selling) a stock … especially one that doesn’t trade many shares each day.
2 Types of Trades
You see, when you buy (or sell) a stock, you can do it one of two ways. You can use a market order or a limit order.
A market order executes “at the market.” That means you pay the current price … no matter how high or low that may be.
A limit order occurs at a price you choose, and not one penny more.
When you are entering stock trades with your broker, I strongly encourage you to use limit orders. The trading activity in FNTE on July 19 in the above chart is a good example why.
To place a limit order, simply select it as an option on your brokerage’s website, and enter the price you want to buy or sell shares at. The image below shows a limit order to buy 100 shares of FTNE at $10.04 per share.
Trading Like This Will Save You a Lot of Money
Since it started trading in March 2017, the median daily volume of the FNTE stock above is only 4,600 shares.
It is essential that you use a limit order if you are buying a stock that trades only a few thousand shares per day. If you only take away one thing from this essay, please make sure it is this.
If a stock only trades a small number of shares a day, there may be just a few people willing to sell shares at a given time. And those people may only sell at a price greater than the market price.
I suspect that happened in the FNTE example above. It didn’t have to, though.
Shares traded between $9.96 and $11.99 on July 19. That tells us it is likely a limit order for a price just above $10 would have been filled.
And it would have saved the buyer a chunk of change.
There Are Trade-Offs
No strategy is foolproof.
There are disadvantages to using limit orders. There is a risk you won’t get into the stock because it may not trade down to your limit price.
There’s also a chance that even if it does trade to your price, you won’t get to buy all the shares you ordered. That’s because sellers may only be willing to sell a certain number of shares at your price.
I hope these issues won’t dissuade you, though. There’s no rule that you must enter a position immediately.
And stocks are volatile. It’s likely that if the order doesn’t fill the first day you enter it, it will later.
Remember, you can enter a limit order slightly above the current price. That way, you increase the likelihood of your order filling while you ensure it doesn’t fill at a too-high price.
Investing isn’t a sprint. If there’s a stock you really want to own, it won’t hurt you if you have to wait a couple days to buy it.
To me, it is more important to get the right price than to enter a position as soon as possible.
Senior Analyst, Banyan Hill Publishing