Like Master P Said, No Limit
How to Trade Like a Pro on Robinhood
So we’ve spent some time, finished our due diligence, and have decided we would like to start investing. Robinhood provides us a few different methods to buy or sell stock.
Market orders, limit orders, stop loss orders, and stop limit orders
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What are they? And when do we use them?
Let’s dive in.
Market order
The most common order is a market order or the default method selected when we initiate a sell or buy order. A market order is an order that will match buyers with sellers based on the lowest selling price and the highest buying price.
Market buy order— this is when we want to buy a stock as soon as possible. When we submit a market buy order, the brokerage will match us with a seller at the best available (lowest) price. There is no guarantee when submitting a market buy order that we will find a seller at the last quoted price. In a time of high demand, we may end up paying a lot more than the price shown.
In our trade window above we see that the last quoted price for a share of PTLA is $29.06 and we are setting a market purchase of 10 shares.
People selling their shares of PTLA will be coming in at different times and different prices. The 10 shares being purchased won’t have the same purchase price; however, Robinhood will display an average purchase price across all 10 shares and this average price will be our cost-basis for tax reporting. This type of cost accounting will be true for all trade methods.
Market sell order — this is when we want to sell a stock as soon as possible. The brokerage matches us to a buyer at the best available price (highest). Similar to a market buy order, the outcome can be higher or lower than expected if there are large imbalances between buyers and sellers.
In general, market orders are great when timing is the biggest influential factor. They are also the easiest order to execute, and there is almost always a guaranteed outcome. An appropriate time to use a market order would be if we had determined that a stock is undervalued and we want to buy it before anyone else catches on.
Non-market orders can be found in the Orders type.
Limit order
Limit orders specify a maximum or minimum price that we are willing to buy or sell our shares. If the minimum requirement is not met, the order will not execute and will sit in the queue. The length a trade will sit in the queue depends on our Time in Force selection.
Time in Force — whenever we have a conditional criteria in our trade execution, we have the option to set a Time in Force. Currently, Robinhood offers two options: Good for day and Good till canceled. Good for day means the order will expire at the nearest market close. Good till canceled gives us 90 days to try to fill this trade. Tip: Good till canceled is useful when we have determined a set price we would like to purchase or sell our shares — It lets us set it and forget it.
Limit buy order —this is an order that sets the maximum per share price we are willing to pay in a buy order. The sellers who fit the criteria will be matched to fill our order in the order they arrive.
For example, we are setting a limit buy price at $29, the most we are willing to pay, for 10 shares for PTLA and we are selecting a time in force of Good for day. Any offers that come in today to sell at $29 or below will be matched with this order.
Limit buy orders are used to protect us from wild price swings. A common use case is to set a limit buy order when buying on the first day of an IPO to avoid overpaying for shares.
Limit sell order — this is an order that lets us set a minimum per share price for which we are willing to sell shares of a single company. Any buyers who offer the same or higher price per share will be matched with us. When setting up this order the Time in Force consideration still applies.
Limit sell orders are useful if there is a minimum price below which we don’t want to sell our shares. For example, if we think PTLA is overvalued at $40 a share, we can set a limit sell order at $40, Good till canceled. If at any point in the next 90 days PTLA goes above $40, we would automatically cash in on our position without needing to vigilantly monitor the price.
Stop loss
A stop loss order is a method of buying or selling that also has a limiting criteria. A stop price is set and once the stop price criterion is met, the whole order turns into a market order.
Stop loss buy order — is an order that triggers a market buy order whenever the stop price is reached. In practice, the stop price is set higher than the current market price because if the stop price is equal to or lower than the current market price, the stop loss buy order becomes the same as a market order since the criterion is met immediately.
A stop loss buy order is used often used to capitalize on any major upswing of the stock. An example would be if PTLA is currently trading at $26.09 but earnings will be reported tomorrow. We didn’t want to buy the stock today because we aren’t sure if the news is going to be all positive, even though we think it will be. We can set a stop loss buy order at $27, meaning if the stock price jumps beyond $27 we’ll buy in at the market value at that moment. In the case it’s bad news and the stock drops, our buy order will never execute.
Stop loss sell order — is an order that triggers a market sell order whenever a stop price is reached. To be effective, the stop price is set lower than the current market price.
A stop loss sell order is used to protect against downward price movements. Think of it as some built-in protection for when shit hits the fan. Once set in place, if our stock price starts dropping beyond the stop price we had set, the trade executes as a market sell order and potentially limits our losses before the stock plummets further. In rapidly declining markets, this order may not provide sufficient protection as the market price can be much lower than our stop price.
Stop limit order
A stop limit order is a slightly more complex stop loss order. At the stop price, instead of triggering a market order, a limit order is put in place.
Stop limit buy order—this is an order that triggers a limit buy order after a stop price is reached. In practice, the limit price should be higher than the stop prices or else this would be the same as a stop loss buy order.
Let’s revisit the same scenario in the stop loss buy order above. We have run some further analysis and while we think PTLA is doing well as a company, we have concluded that anything over $31 per share is overpriced. We will set a stop price at $30 so any upward price movement the next day will trigger our limit buy order. Our limit buy order will also make sure we don’t pay more than $31 per share. When this trade executes, we should expect an average per share price between $30 and $31 per share.
Stop limit sell order — this is an order that triggers a limit sell order after a stop price is reached. Again, the limit price should be lower than the stop prices or else this would be the same as a stop loss sell order.
A good use of a stop limit sell order is if we want to lock in some gains for some of our stocks that have greatly appreciated. Let’s assume that we had bought PTLA at $30 a share and now the shares are trading at $40 per share. We are worried that it’s close to being over-valued and we think the fair value is around $38 per share. However, we want to hold onto the shares if the price continues to rise. We will set a stop limit sell order with a stop price of $39 and a limit order of $37. This means once people start selling enough to make the stock price drop to $39, we will initiate a limit sell order with the minimum price of $37 so that we don’t sell for less than what we think the shares are worth.
What we covered in this post only represents the options that Robinhood offers to submit buy or sell orders. Depending on your brokerage, there may be more or fewer options than the four we covered today. For most first time investors, market orders are more than sufficient. Setting useful stop and limit prices requires a foundational understanding of how to value companies and the shares in the companies.
We plan to release a complete lesson series around fundamental company valuation principals and how to determine whether a stock is overvalued or undervalued. Stay tuned and sign-up for the waitlist.
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