Trading ETFs: Basic Order Types

Posted 08/24/2009, 9:00 am EST by Staff from ETFguide.com

Since exchange-traded funds (ETFs) are bought and sold just like stocks it�s important to be familiar with the fundamentals of order placement.

When buying or selling an ETF, the quality of your trade�s execution will be impacted by the type of order you place. A clear understanding of various order types will help you to achieve the results you want.

Here are some of the advantages and disadvantages of each order type.

Type of OrderDefinitionAdvantagesDisadvantages
Market An order to buy or sell an ETF at the market�s current best available price.Typically ensures immediate execution.Order may get filled at different prices and times, especially in fast moving markets.
Limit An order to buy or sell an ETF with a restriction on the maximum price to be paid or the minimum price to be received. Also known as the �limit price.� If filled, your order will only be executed at your specified limit price or better. No assurance of order execution.
Stop An order to buy or sell an ETF at the market price once the ETF has traded at or through your specified price. Also known as the �stop price.� Designed as an automatic trigger for an order entry or exit once a certain price level has been achieved. Order may get filled at a much higher or lower price than the ETF�s price, especially in fast moving markets.
Stop Limit Combines a stop order and a limit order to buy or sell an ETF at a specified limit price (or better) only after the stop price has been reached. If filled, your order will only be executed at limit price or better. Also provides an order entry or exit threshold. No assurance of order execution.
Short Sale A trade that involves selling an ETF you do not own because you expect to purchase it back later at a lower price. A decline in the ETF�s price provides the potential for a profit. An increase in the ETF�s price could force you to buy it back at a substantially higher price you sold it for, resulting in a loss; your account will accrue margin interest for the amount of time the ETF is borrowed.