Daily Gains Letter

Two Simple Ways to Reduce Your Costs When Trading Stocks

By for Daily Gains Letter | Apr 10, 2013

















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Hope for the best and prepare for the worst may be one of the best strategies an investor can employ, especially if they are in the world of investing for the long haul and want to preserve their capital. As I always say in these pages, fluctuations are part of the market—the market will move and react to different news, but you have to make sure that your assets are protected.

Investors can use asset allocation, diversification, and risk management to preserve what they have. But if you add the following types of orders to your investing arsenal, your returns can increase, and you can save a significant amount of money over time.

Limit Orders vs. Market Orders

Consider this: if you are trading a thinly traded or volatile stock and the spread between the selling price and the buying price is significant, what would you do? If you go ahead and buy with a market order, you will certainly get the stock, but the price you get may not be the price you wanted in the first place.

In situations like these, limit orders become very useful. Through this order type, investors provide instructions to the broker to buy or sell a stock at a certain price (or cheaper), rather than getting whatever price is available.

For example, Apple Inc (NASDAQ/AAPL) shares are trading at $425.10. If an investor places an order to buy 100 shares at market price, then they might not get the $425.10—the price could be higher or lower at the time of purchase. In contrast, if an investor places a limit order with a price of $425.10, then the broker will not execute the order until they are able to get the shares at the instructed price or lower. (Note: this is not a recommendation to buy; just an illustration.)

Trailing Stop-Loss Orders

Buying a stock is very simple; all an investor has to do is place an order. Unfortunately, the most difficult part is the selling—or as it is also called, the “letting go of the position.” When it comes to selling, investors often ask: is it the right time to sell? Will the price go any higher or lower?

Trailing stop-loss orders take out the guesswork and emotional pressure from selling a stock holding—either from a loss or profit.

At the very core, a trailing stop-loss order is similar to a stop-loss order, which tells the broker to sell the stock at a price that is a certain percentage below the market value.

Consider this example: you buy 100 shares of ABC Inc. at $10.00 a share. A few weeks later, you find that ABC’s shares have soared, and they now are trading at $15.00. Should you sell? In a case like this, investors can set a trailing stop-loss order of 10% below the market price. If the price drops 10%, the investor locks in their profit and exits the trade.

If the price continues to increase, then the trailing stop-loss—which was 10% below the market price—keeps increasing as well. This way, the investor can lock in the profit as the price increases, rather than missing out on the gains.

Instead of going with the ordinary market orders to sell or buy their investments, with these orders, investors can benefit over the long run. If by using a limit order an investor saves $0.05 per share, over a long period of time, this can add up.

Similarly, with a trailing stop-loss order, it may look like the investor is missing out on some gains at first, but what if the stock price goes higher? If by using trailing stop-loss orders an investor makes a mere extra one percent on the trade, the return over time can be phenomenal.

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