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Trading Equities

Other than some type of savings account or

other interest-bearing instrument, the first venture into investing

for most people is probably the stock market, either in individual

company equities or in mutual funds of many different types. Many

people have a stake in the stock market through their 401(k) or

other retirement plans.

Buying a stock gives you a piece of the

company, entitling you to collect dividends and gaining from any

appreciation in the value of the stock. Companies sell these shares

to raise money for all kinds of reasons, granting ownership rights

rather than borrowing money and paying interest. Unlike many

derivative instruments, stocks do not expire and can be held

indefinitely. For that reason,

The supply of a company's shares is fixed. With

a limited number of stocks, competitive buying and selling

determines the price of the stock. Stock markets normally operate

with a specialist system with market-makers responsible for making

markets in specific stocks.

The Federal Reserve sets the margin amounts for

stocks, requiring investors to have a minimum of 50 percent of the

price of stock in their account as a down payment to own the stock.

It is much more difficult to sell stocks than buy them as selling

usually has to be done on an uptick, and you have to borrow shares

from a brokerage firm's inventory if you want to sell. If you borrow

margin money to buy shares or borrow shares to sell, you pay the

broker interest.

Trading

Individual Stock Instruments

You have a number of alternatives to become

involved in the stock market as either an investor or trader.

Individual

Company Shares

You have thousands of choices, and your biggest challenge

is to pick the right stock from the right sector from the right

overall market environment at the right time. Much of the analysis

for investing in individual stocks involves scanning through the

vast array of stocks to find those that meet the criteria you

select. Getting accurate data and reliable information about a

company in a timely manner can make it difficult to get an edge.

Stock Options

Instead of buying shares in the company, you can use

options to buy or sell the right to be long or short the company's

shares at a specific price.

Single Stock

Futures

Futures on major individual stocks began trading in

November 2002 but still trade on a relatively small scale. Single

stock futures do provide greater flexibility and tax advantages for

those wanting to buy or sell selected major stocks.

Trading 'Market' Instruments

Many investors do not have time nor expertise

to evaluate and select the "right" individual stocks so various

instruments have been developed to capture the performance of a

broader spectrum of stocks.

Mutual Funds

Mutual funds package stocks from a sector, from a region,

the market as a whole or many other ways to provide a diversified

fund based on a collection of individual stocks. Basing performance

on a number of stocks reduces risk and can enhance profits compared

to investing in a few individual stocks. Funds can be geared to

provide aggressive growth, growth and income, long-term appreciation

or a number of other investment goals, and their performance is

often measured against some benchmark.

Mutual funds

have become so popular and the number of funds so numerous that it

is now as difficult to pick a "good" mutual fund as it is a stock.

Although these funds offer diversity and professional management for

investors, they have some limitations and may not be the best

vehicles for active traders.

Index Funds

Rather than select individual stocks for a fund, some

funds just include all of the stocks in an index such as the S&P 500

Index or one of the sector indexes. Their performance should roughly

coincide with the performance of the index.

Index Options

These derivatives are also based on an actual cash index

such as the S&P 500 Index (SPX) and the S&P 100 Index (OEX), which

cover a number of stocks. Overall market direction and time are

important elements to consider.

Exchange-Traded Funds (ETFs), Index Shares, Index Tracking Stocks

These products

act like an index but are traded like a stock and have become very

popular since they were introduced by the American Stock Exchange in

1993. More than 300 ETFs are available today. The most popular

leaders include:

• DIA or "DIAMONDS" based on the Dow Jones

  Industrial Average and priced at approximately 1/100 of the

  value of the DJIA.

• QQQ or "Qubes" based on the Nasdaq-100

  Index and the most successful index share contract. It is priced

  at approximately 1/20 of the value of the index.

• SPDRs based on the S&P 500 Index.

• Select Sector SPDR Funds based on nine

  specific industry sectors.

• WEBS World Equity Benchmark shares on 17

  different foreign countries based on Morgan Stanley Capital

  International (MSCI) Indexes.

• HOLDRS depository receipts on selections

  of stocks in various areas.

ETF instruments offer traders a number of

advantages:

• Invest in a portfolio of stocks

  represented by an index with a single transaction in one

  stock-like instrument.

• Provide diversification of a stock index

  one trade buys or sells "the market."

• Trade short-term or long-term no time

  factor, no expiration like futures or options, no penalty fee

  for getting out before the 6-12 month minimum time period that

  some mutual funds require.

• Trade continuously throughout the trading

  day, unlike mutual funds, which can be purchased or redeemed

  only at the end of the day.

• Marginable just like stocks.
• Short selling allowed on a downtick any

  time during the trading session, unlike many common stocks.

• Limit orders can be used to sell or buy at

  a specific price without having to wait for whatever the close

  is on a given day.

• Dividends accrue to stocks in the index.
• Move into and out of positions quickly as

  a proxy for stocks.

• Lower cost than buying multiple stocks in

  an index.

Stock Index

Futures and Options on Stock Index Futures

Trading in

stock index futures goes back to 1982 and has evolved into one of

the most successful electronically traded markets with contracts

based on the S&P 500 Index, Dow Jones Industrial Average and

Nasdaq-100 Index.

As the

stock market soared in the late 1990s, the size of the S&P 500 Index

was reduced several times to be more compatible with individual

trader accounts. Originally priced at $500 times the index, the

full-sized contract was cut in half to $250 times the index. The

most popular index futures contract now is the S&P 500 e-mini, which

has a multiplier of $50 times the index and is traded electronically

almost around the clock. The e-mini Nasdaq-100 Index, with a

multiplier of $20 times the index, has also become popular for

short-term trading.

Trading Futures

Many people associate futures with risk, but

after the technology stock bubble of the late 1990s and the

accounting scandals and fraudulent dealings at Enron, Worldcom and

other companies, futures may look a lot less risky than many stocks.

Futures do have some inherent risk, but they can also actually

reduce some of the risks that exist in the investment world. For the

active trader, futures offer one of the best ways to get big returns

quickly while helping you keep your risk under control.

Here are the characteristics of a futures

contract:

Temporary Replacement for a Future Transaction

A futures contract is an agreement today to

meet the terms and obligations of a contract that matures at a

specific date in the future. When you buy futures, you do not "own"

anything but have the right to benefit from price appreciation; if

you hold a long physical commodity futures contract until

expiration, you may take delivery and own the actual commodity. If

you sell futures, you do not "owe" anything but have the right to

benefit from price depreciation; if you hold a short physical

commodity futures contract until expiration, you are required to

deliver the commodity to the buyer under terms specified by the

contract.

Performance

Bonds

One of the first things you need to realize

about "margin money" is that it does not mean the same thing in the

futures market as it does in the equities market. The futures

contract does not involve a down payment for future delivery as is

the case in stocks. Instead, futures involves putting up an

established "good-faith deposit" or a "performance bond" that

confirms your willingness to fulfill the terms of the contract. It's

like earnest money in an escrow account and is required for both the

buyer and seller of a futures contract.

Exchanges set the minimum performance bonds for

each futures contract, and these amounts change as market conditions

change. Typically, the amount is only 3%-10% of the value of the

contract, but the amount could be greater in volatile market

conditions.

Standardized Contracts

In many transactions, specifications can be

tailored to fit the needs of both parties, and the contact may be

one of a kind. In futures, one contract is the same as any other

futures contract for the same market, same month and same size.

Contracts are interchangeable or fungible. The only thing in a

futures contract that is not standardized and regulated is the price

at which the transaction takes place. The corn you would receive at

delivery for one futures contract, for example, is the same grade

and type and quality as for any other corn futures contract.

Exchange-Traded

Futures contracts have two key characteristics:

(1) They must be traded at a centralized marketplace an

open-outcry or electronic exchange where all bids and offers come

together and are matched in trading conducted by specific rules

under the oversight of government regulators, and (2) the terms of

the contract are guaranteed by a centralized clearinghouse so you

never have to be concerned about a default on a contract. The

exchange's clearing agency takes the opposite site of every futures

transaction and resolves any potential disputes.

Time

Element

Futures have an expiration date, usually a

relatively short time into the future for the most active contract

months. There is no buy-and-hold in futures because when the

contract expires, it is settled according to the terms specified and

goes off the board. Therefore, in addition to price direction,

futures traders also have to consider the time frame within which

they expect a price move to occur.

Why Futures Exist?

Futures are important tools in the business

world for several legitimate purposes:

Price

Discovery

Futures trading provides the means to determine

market value in a centralized marketplace that brings together all

the "bid" and "ask" (or "offer") prices to arrive at a value agreed

upon by both the buyer and seller. Like any other auction market,

traders bid on an item for sale and discover what other people think

it is worth in a competitive setting. Bids and offers come from a

variety of sources with a variety of motives for being involved in

the market. By centralizing all buying and selling activity with the

largest possible pool of participants, the market determines value

at that particular moment in time.

For many physical commodities still traded on

an open-outcry floor, the price established at the exchange is the

price quoted around the world and is the basis of much physical

trading.

Risk Transfer

Other than price discovery, perhaps the most

useful purpose of futures is to transfer risk from someone who has

it to someone who is willing to assume it. The market underlying

futures carries real risk. Those bearing the risk of price change

producers of a commodity or owners of stocks in a stock index, for

example may use futures to pass that risk to someone who thinks

the market will provide them with a profit for their willingness to

take the risk.

All markets carry a risk for someone, whether

prices go up or down. Futures produce no new risk but just shift the

risk that exists in a transaction where both parties hope to benefit

from a price movement in their direction.

Why Trade

Futures?

"Commercials" or "hedgers" usually have

business reasons for using futures to lock in prices or profit

margins. For them, futures provide a way to reduce risk and to

develop a sound business plan because they can remove some of the

uncertainty about the future.

For many other futures market participants,

however, the most important feature of futures is the ability to

speculate on price movement with a relatively small amount of money.

Here are some reasons why traders like futures:

Leverage

One of the first terms associated with futures

is leverage a small amount of money in futures has the potential

to produce big returns. Of course, that feature can also have a

downside if you do not manage your risk carefully. That means you

need to monitor a futures position more carefully than you do most

other trading instruments.

Here is a simple example to illustrate the

power of leverage:

1. Assume you have $10,000 to invest/trade. You

buy 500 shares of a $20 stock, paying the full price or all $10,000.

If the stock goes up $5 a share or 25%, you gain $2,500 (500 shares

X $5). Your return on investment is 25% ($2,500/$10,000).

2. You use the $10,000 to buy 1,000 shares of

a $20 stock, paying the required 50% minimum margin and borrowing

the rest. The value of shares you own is now $20,000. If the stock

goes up $5 a share or 25%, you gain $5,000 (1,000 shares X $5). Your

return on investment is 50% ($5,000/$10,000).

3. You put the $10,000 into a futures account and use it to

buy two e-mini S&P 500 Index futures contracts. With the index at

1200, the value of your futures position is $120,000 (2 X 1200 X $50

per point). If the price of the index goes up 25% or 300 points, you

gain $30,000 (300 points X 2 contracts = 600 total points X $50 per

point). Your return on account is 300% ($30,000/$10,000). Of course,

an index spread over 500 stocks is not as likely to rise 25% as is

one $20 stock, but even if the S&P 500 Index goes up only 5%, you

make more than you would with the 25% rise in stock prices.

What is important to remember is the other side

of this leverage if the market should fall 25%. In Example 1 with

the fully-funded stock purchase, a 25% loss would be $2,500, leaving

you with $7,500 of your original starting amount. In Example 2 with

the partially-funded purchase, a 25% loss would be $5,000, leaving

$5,000 remaining in your account. In Example 3 with two e-mini

futures contracts, a 25% loss or 300 points would amount to $30,000

or three times your starting account size. And you would be legally

obligated to pay if you rode through that decline. Even if the

e-mini dropped only 5% to 1140, you would lose $6,000 or 60% of your

account.

While leverage can work for you, it can also

work against you, making risk management and cutting your losses

short two of the most important steps in futures trading.

Ease of Selling Short

One concept that seems to be difficult for many

traders to grasp is the ability to sell something they don't own. In

futures, however, remember that you don't own anything but are only

agreeing to abide by the terms of the contract at some later date.

Your performance bond acts as your guarantee for that agreement.

Your futures position is simply the right to speculate on price

movement up or down between the time you enter the position and the

time you offset it.

Therefore, it as easy to sell futures as it is

to buy. Everything about the trading process is the same except that

you say "Sell" instead of "Buy." In addition to "buy low, sell

high," you can also "sell high, buy lower."

Fast, Efficient Transactions

Futures transactions can be executed in seconds

on a trading floor or in nanoseconds electronically. With today's

technology and many participants normally willing to take the other

side of any order, you usually get not only a speedy turnaround but

also into and out of a position at prices close to what you want.

Bid and ask spreads are relatively narrow in the most active

markets, which can absorb sizable orders without disrupting the flow

of prices.

In addition, the costs of establishing a

futures position are quite reasonable as commissions have gotten

lower and lower as competition has intensified recently.

Protection, Insurance

Without futures to provide protection, some participants could face

losses from adverse price moves. Even if you have a relatively small

investment portfolio in stocks, you might consider using single

stock or stock index futures to provide protection against a

downturn in the stock market while keeping stock holdings intact. Or

if you suddenly receive a large sum of money that you want to invest

in stocks, you could put the money to work quickly with a position

in futures while you assemble the portfolio of stocks you want.

The Role of the Exchange

Other than the trading that takes place in the

more specialized over-the-counter markets and cash foreign exchange

trading, the exchange is the centerpiece of much of the trading

action in derivative instruments, whether trading is conducted via

open outcry on a trading floor or electronically on a computer.

In recent years exchanges have been challenged

to keep up with advances in technology, with changes in ownership

from member-only entities to publicly traded companies and with the

development and expansion of competitive new exchanges operating in

a global environment. Technology requires huge investments in

equipment and software applications as more and more participants

trade electronically, but it also reduces the per-trade cost of

trading, allows more new products to be offered online (sometimes

the same product offered on another exchange) and improves the speed

and efficiency of trading, which attracts even more trading.

Here are some roles that exchanges fill in the

trading process:

Centralized Marketplace

Whether trading occurs in a pit or a computer,

the exchange provides one centralized location where buyers and

sellers can gather to match their orders. This pool of traders

expedites the price-discovery and risk-transfer processes. Details

about the results of this trading activity provide the price

structure for many of today's markets.

Product Offerings

Every viable business has to offer products or

services. In the trading world it is the exchanges that create,

develop and market the products that are traded, frequently doing

the research to support the contract and producing the materials to

promote their markets to traders. Exchanges do not own the product

or carry an inventory; they just turn concepts into a tradable

contracts and post them for the world to see and trade.

Trading Rules

Exchanges have developed a set of detailed

trading rules over the years that govern how trading is conducted in

a central location. These rules protect traders, whether on a

trading floor or a computer screen, dictate how various orders

should be handled and place restrictions on price manipulation,

front-running or insider trading. Maintaining the integrity of the

trading process is vital to building trust and confidence in the

marketplace, which is what allows exchanges to function in the first

place.

Futures exchanges also set performance bond

requirements for all of its contracts, a role that the Federal

Reserve has for the equities markets.

Trade Matching

For every buyer, there must be a seller, and

for every seller there must be a buyer. The exchange provides the

facilities and the rules to match buyer and seller and makes trading

a more orderly process than the chaotic scene sometimes depicted in

the media.

A clearing organization, sometimes operated by

the exchange and sometimes a separate entity, works with clearing

members of the exchange to make sure that all positions balance out,

assuring that the appropriate amounts of margin money are deposited

and resolving any discrepancies. In futures, the clearing

organization actually acts as the buyer to every seller and the

seller to every buyer to protect against the risk that a

counter-party will not hold up its side of a transaction.

The Role of the Brokerage Firm

Although most trading takes place on an

exchange, you can't get there without going through a broker, your

entr to the trading world. In fact, your only contact with trading

may well be your broker as you may not know or care which exchange

is executing your order.

The broker serves a number of functions in

addition to holding your trading account and transmitting your

orders to the exchange. Depending on the level of service you

require, the broker can educate you about trading; provide you with

data, price quotes, research reports and other information; offer

trading recommendations, or perhaps even trade your account for you

in a managed account. For more information on how to determine what

type of broker you need, see the section in this tutorial on picking

a broker.

At a minimum a brokerage firm serves as a

conduit to expedite your orders, reports confirmations and provides

you with account statements of your activity.

An important broker function is to determine

traders' "suitability" for trading various instruments based on

their financial status and their eligibility to trade specific

positions based on the amount of money in their account. As a

gatekeeper to the trading arena, the broker also helps the futures

or securities industry maintain the integrity of the trading process

by screening every customer and every order as part of its fiduciary

responsibility to collect, hold and monitor the funds you entrust to

a segregated customer account.

All U.S. brokerage firms must be registered

with government regulatory agencies. Depending on their level of

financial backing and the services they provide to traders, futures

brokerage firms may be classified as futures commission merchants (FCMs)

or introducing brokers (IBs). Individual futures brokers are

registered as associated persons (APs).

The Role of the Regulators

Government

regulators act as watchdogs, overseeing trading in the securities or

futures industries. Although industry officials sometimes complain

about too much oversight and regulators sometimes claim the industry

isn't providing enough, the check-and-balance tension between them

helps to guard the public interest and maintain a level trading

field for all investors and traders. Nearly everyone can agree that

a balance of regulation is a good thing because its existence gives

the public comfort and confidence that an outside source is guarding

their interests.

In addition to

providing or approving market regulations, the regulators also

provide traders and consumers with valuable details about the status

of brokers and firms, warnings about investment scams, advice on how

to invest and other useful information. Their enforcement actions or

threats of action reduce the negative aspects of the industry and

help to keep it as "clean" as possible.

Regulators on the

equities side include the Securities and Exchange Commission (SEC),

www.sec.gov; Federal Reserve, which controls margin requirements,

and the National Association of Securities Dealers (NASD),

www.nasd.com. Regulators for the futures industry include the

Commodity Futures Trading Commission (CFTC), www.cftc.gov, and the

National Futures Association (NFA), www.nfa.futures.org. Generally,

persons who handle your money must be registered with a regulatory

agency.

The

Securities Industry Association (SIA) and the Futures Industry

Association (FIA), www.fiafii.org, are the national trade

organization for these types of trading instruments.

How to Pick a Broker

The broker you select depends on the level of

service you need. An experienced trader may get along well with a

discount brokerage firm that merely executes orders at low

commission rates whereas a beginning trader needing more help may be

willing to pay higher commissions for the services of a full-service

brokerage. There is no single, best answer to which broker is the

best because there are many different types of traders and brokers.

Like any profession, there are differing

degrees of quality in futures brokers and brokerage firms.

Obviously, your first goal in selecting a brokerage firm should be

finding a firm that is reputable. Your personal broker within that

firm is like your employee because he/she will be working for you

and you will be paying him/her. So you may want to interview them

just as if you were hiring someone for a position.

A broker should be honest and have your best

interests in mind not a "churn and burn" pitch man who racks up

big commission fees by cajoling you into trading all kinds of

markets. Sometimes traders find it hard to blame themselves for

unsuccessful trades, and the broker is an easy scapegoat. Certainly,

there are a few "bad eggs" in the brokerage community, just as there

are in every industry. However, the vast majority of futures brokers

are honest and hard-working individuals who do have your best

interests in mind when it comes to trading.

No matter whom you select as a broker, you have

to take ultimate responsibility for your own trading decisions. At

the same time, it is not an exaggeration to say that the ultimate

success or failure of some traders lies in the hands of their

brokers.

Search Tips

• Decide what you

  want from a broker before you begin your search. If you trade

  electronically and only need fast order executions at low cost

  and an accurate accounting of your trades, a discount brokerage

  may be the best for you. If you need price quotes, background

  research and other types of information to make a decision and

  need to have help in framing orders, you should look for a

  full-service brokerage firm, even though you will have to pay

  more in commissions. If the broker helps you get into profitable

  positions, they are well worth the fees they charge.

• If you have the

  money but lack the time or knowledge to trade your own account,

  one aspect of your search may be to find out whether the

  brokerage firm has money managers or trading systems that can

  trade an account for you. You may even want to have one account

  traded by a professional and another account that you trade

  yourself as one way to diversify your trading portfolio or to

  see how your trading skills compare with an expert's.

• Less-experienced traders will probably want to avoid the overly

  aggressive broker, who can make trading an intimidating

  experience, especially since many newer traders are often still

  learning the terminology and may be confused by

  sometimes-hard-to-understand trading concepts. Find a broker who

  can talk to you on your terms comfortably.

• As an

  individual trader, you and not your broker should always be in

  control of your trading account and your trading decisions, even

  if you are inexperienced. If your broker gives you

  recommendations, you can certainly act upon them. But it's your

  money, and you should control your trading decisions. Helpful is

  one thing, pushy is another. Find a broker who is compatible

  with your style of thinking and trading one who will answer

  your questions and work hard to get good fills for you if you

  are not trading electronically but who will not question why you

  want to make a particular trade or give you his opinion on a

  trade.

• Having made the

  case for making your own decisions and controlling your own

  trading, keep in mind that many brokers do their own research

  and provide their information to customers, including trading

  opportunities. This type of research may be as high in quality

  as any available, so don't rule out using information from

  brokers or advisors in making your trading decisions or relying

  on their expertise. They are usually in a better position to

  analyze markets than you are.

• Check out any

  brokerage firm or individual broker by contacting the National

  Futures Association (www.nfa.futures.org) and using its "BASIC"

  system, which performs searches of brokerage firms or individual

  brokers to find out if they have had any infractions levied

  against them by the NFA. The Commodity Futures Trading

  Commission (www.cftc.gov) also has an informative website that

  can help size up a new broker or brokerage firm.

How to Place

Orders

No matter how much analysis you do or how

sophisticated your software is, virtually nothing in trading is more

critical than entering your orders properly. It is hard enough to

determine the trades you want to take. Communicating your trading

decision to the market can be another challenge if you are a trading

newcomer unless you work with a broker or experienced trader who

can explain the terminology, the strategies and the nuances of the

various orders.

Remember, it's your money the broker is holding

so you should be very careful about telling the market what you want

to do with your money.

Before discussing the various types of orders,

here are a couple of important points:

1. Not all orders are accepted at all

   exchanges or by all brokerage firm trading platforms. Check with

   your broker to be sure which orders you can use for the markets

   you trade.

2. Entering a trade is not the end of the

   order process. Be sure that you get a confirmation that your

   order has been executed and the price at which the order was

   filled. That fill shows where you stand in the market and may be

   the key to followup orders such as stops.

3. Never assume that a broker or a computer

   knows what your position is or what you are trying to

   accomplish. If you say or click "sell" instead of "buy," your

   order is likely to get executed, and you may wind up doubling

   the size of a short position when you thought you were closing

   out the short position.

4. Keep your own order log, especially open

   orders because they may lie in some forgotten queue long after

   the market has moved away from the area where they were placed

   and give you a big surprise if they are filled.

Types of Orders

Below are some of the most common types of

orders and where you might use them, either to enter or exit a

position. To understand the consequences of an order more fully, you

may want to work with a broker, at least initially, until placing

orders becomes second nature to you.

Market Order

A market order is the most common type of order

and should be used whenever you want your order to be executed

immediately. You do not have to indicate a specific price because

the order will be executed as soon as possible at whatever the next

available market price is. Once this order is placed, it cannot be

canceled because it is filled immediately.

Keep in mind that the next available price may

be far removed from the price at the time you placed your order in

wild market conditions. This is known as "slippage" and can be one

of the most costly aspects of trading, especially in "thin" markets

that may have large price jumps. Do not use "at the market" orders

in thin markets or in volatile conditions unless it is imperative

that you get into or out of a position at whatever price you can

get. Although those situations do exist sometimes, the market may

take advantage of you if you resort to the market order.

Market on

Close (MOC), Market on Open (MOO)

Some traders call this order "murder on close"

or "murder on open" because those typically are the periods of the

regular floor trading session when the markets are most active and

the odds are higher for the execution price to be away from the

posted current price. These are just market orders that must be

filled within the price range during the official designated closing

or opening time periods. The MOC order may be very useful to close

out a day-trading position that you do not want to hold overnight,

but keep in mind that it does have its risks.

Limit

A limit order specifies a price limit at which

the order must be executed you get the price you want or better or

you don't get a position. A limit order lets you know the worst

price at which your order will be executed. However, you cannot be

certain that a limit order will be filled because the market may not

trade at your price, or there may be only a few trades at the limit

price level you specified and yours is not one of the orders filled.

With a limit order, the tradeoff for being sure about the worst

price you can get is that you may not get a position at all.

A buy limit order is placed at a price lower

than the current market price. A sell limit order is placed at a

price higher than the current market price. Some traders add "or

better" to a limit order to reinforce their intent, but that is

implied in a limit order and is not necessary.

Market If Touched (MIT)

A market-if-touched order combines some

features of both the market order and the limit order. Like the

limit order, a MIT order may be executed only if the market reaches

a particular price. Unlike a limit order, when that price is

reached, the MIT order becomes a market order, executed at the next

possible price available. That means a MIT order could be executed

at the MIT price, at a lower price or at a higher price.

An MIT buy order becomes a market order if and

when the market trades at or below the order price. The MIT order

does not guarantee that you will buy at the limit price or lower. On

the other hand, if the market bounces back above the MIT price, it

does get you into a long position whereas a limit order would not.

An MIT sell order becomes a market order if and

when the market trades at or above the order price. The MIT order

does not guarantee that you will sell at the limit price or higher.

If the market falls back below the MIT price, it does get you into a

short position whereas a limit order would not.

The advantage of the MIT order is that you know

your order will be filled if the MIT price is hit. The disadvantage

is that you do not know the worst price at which the MIT order might

be executed because it is subject to the same market gyrations as

the market order once the MIT price has been reached.

Stop

A "stop" is another common order because

traders are always being admonished to trade with stops to protect

their accounts. The stop is often used as a protective order, but it

is also a good way to get into a new position. A stop order is

essentially a market order but only if and when the market reaches a

specific price. The specified price acts as the trigger that

converts the stop order to a market order. Until and unless that

trigger is pulled, your market order stays on the shelf waiting to

be activated.

A buy stop order is placed at a price higher

than the current market price. It will become a market order to buy

only when the market moves up to that price. Like any market order,

the trade may be executed at the stop order price, at a lower price

or at a higher price, depending on the next best possible price

available.

A sell

stop order is placed at a price lower than the current market price.

It will become a market order to sell only when the market moves

down to that price. Like any market order, the trade may be executed

at the stop order price, at a lower price or at a higher price,

depending on the next best possible price available.

Source:

VantagePoint Intermarket

Analysis Software

The chart above will help to illustrate the

difference between a limit and a stop order, the most common orders

after the market order. You could have taken a long position one of

two ways:

• A buy stop

  order at the blue line would have become a market order once

  your stop price was hit. Note that there was some slippage as

  the market gapped above your stop order, but it did get you into

  position for the uptrend.

• A buy limit

  order at the red line would have gotten you into a long position

  at that price or lower. If you did not expect prices to dip too

  far below the earlier lows indicated by the red line support, a

  buy limit order placed at that level was a good choice. If

  prices had barely touched the red line, however, the danger is

  that your limit order might not have been filled at all, and you

  might have missed the start of the uptrend.

On the other hand, a sell limit order at the

blue line would have gotten you into a short position at that price

or higher in this case, much to your chagrin if that is the type

of order you chose. A sell stop order at the red line would have

become a market order when that price was hit, and you would have

been short at the next possible price, which might have been at,

above or below the red line stop price again, not a good thing in

this case as the market turned around right after you got into a

short position and moved sharply higher. Of course, you probably

would have adjusted your orders to offset that position before

losses mounted too high.

Stop Close

Only

Like a market on close order, this variation of

a stop order limits the time of execution to the closing trading

range. If the stop is hit prior to that that time, the order is not

executed. If the market is trading higher than the buy stop price or

lower than the sell stop price during the closing range, the order

becomes a market order and is filled at the best possible price.

Stop Limit Order

If the stop order sometimes serves as a

protective order, then the stop limit order acts as sort of a

protective order for the stop. Because stop orders become market

orders when the specified stop price is hit, the order can be filled

at almost any price. When a surprise news event hits the market, for

example, prices can make a huge jump. Or when the market approaches

a critical chart point that suggests a breakout, numerous stop

orders may be sitting above or below that point and may create

temporary erratic price movements if the stop is hit.

You may be one of those with a sitting order

waiting for the breakout, too, but you are not willing to pay any

price to get onboard. A stop limit order acts like a stop order in

every way except for one provision: You will not accept a price that

is worse than the limit stated. Like any limit order, the risk is

that you never get onboard a runaway market that never looks back.

Cancel, Cancel Former Order, Cancel/Replace

All of these orders cancel previous orders,

provided, of course, that you enter them before the original order

has been executed. Several notes about cancel orders:

• You cannot

  cancel a market order; it should already have been executed.

• Many electronic

  markets do not allow "good 'til cancel" orders. You have to

  enter a new order such as a stop every day.

• In some markets

  any "open" or "good 'til cancel" order remains active until it

  is filled, you cancel it, or the contract expires; it does not

  go away because you may have forgotten about it or because you

  may have thought you were offsetting it with a different order

  later.

• If there is any

  question as to whether an order has been canceled, contact your

  broker immediately; if a cancel order is too late, you may wind

  up with two positions instead of one or you may be holding a

  position you never expected.

One Cancels

Other (OCO)

A one-order-cancels-the-other-order is a

two-sided order that is sometimes used to bracket a price range when

you are unsure about the price direction and want to go with the

breakout either way. You could place two separate orders in this

situation, but the problem is that both might be filled in a

swinging market. You could be locked into a quick loss or wind up

with a larger position than you wanted or just become totally

confused.

For

example, you may have decided that you want to be short a market so

you enter an OCO order one limit order above the current price to

sell in case prices go up and one stop order below the current price

to sell in case prices slide through some point. You only want one

position, but you want to be prepared for either eventuality. Your

OCO order tells the broker to fill one order, not both of them, to

get you short whichever way prices move.