After it’s all done, you sit back and relax knowing you made a great trade. Life is good… That is, until you realize your broker got you in at a terrible price – a price far higher than you wanted.

I see this happen all the time.

Every month I recommend at least one stock in my newsletter, Penny Stock Fortunes. I tell people exactly why I like the company, what the ticker symbol is and most importantly, what price to buy up to. Take this Monday for example…

I issued a buy alert for a small-cap company with a lot of upside potential. After reading the company’s annual and quarterly reports, I discovered four catalysts that could boost the stock higher in the weeks and months to come. And when I saw that company insiders (including the CFO, Chairman of the Board and several directors) just spent over $200,000 of their own money to buy the stock for themselves a few days ago, I knew that something good could happen – and soon. So I dropped everything, wrote up my analysis and sent it out to my readers via email.

At the time, this stock was trading for about $6 a share. And based on calculations I made, I told people not to pay a cent more than $6.50.

So what happened?

I sat at my computer screen and watched people get filled all the way up to $6.80 – 30 cents higher than I said to buy up to.

Terrible!

People either ignored my advice completely or placed the worst kind of buy order you can possibly use – a market order.

A market order is an order to buy or sell a stock at the current market price. Sounds ok, BUT…

When you place a market order to buy a stock, it may not be filled at the price you expect or in the timeframe you expect. For instance…

When your broker receives your market order, he may send it directly to an exchange (like the NYSE) to be filled. But he may also send your order to a regional exchange or to a firm called a “third market maker” – who tends to get paid (by your broker) to execute the trade. Basically, when you place a market order you are subject to a lot of re-routing and time delay that can be very costly – especially if you are trying to get in or out of a fast-moving or illiquid small-cap stock. And get this…

While your broker must execute your order in a reasonable fashion, there is no SEC regulation that requires a trade to be executed within a set period of time.

I’m sure you have read stories of people placing an order in the morning and not being filled until the afternoon – at a MUCH worse price than they expected. That’s the risk you take when you use a market order. You are at the mercy of your broker, the regional exchanges and the third market makers.

Let me say it loud and clear…

DO NOT USE MARKET ORDERS TO BUY SMALL-CAP STOCKS! What you should do is use a limit order instead.

A limit order is an order to buy or sell a stock at a specific price. For instance…

Lets say you are willing to own stock ABC at $4 a share. But you don’t want to pay more than that. What you do is place a limit order with your broker to buy stock ABC at $4 or under.

By using a limit order instead of a market order, your broker cannot fill your order for a cent more than you tell him to. So in the example above, he could only buy ABC stock for $4 or less. No ifs, ands or buts about it.

The nice thing about limit orders is you never chase a stock higher than you want to. And you don’t have to worry about your broker re-routing your order to a million people before getting filled.

Of course, there is a risk you take every time you place a limit order.

If a stock is trading at $4.10 a share and you place your limit order at $4, you may never be filled. Remember, unless that stock comes down to $4 or less, your broker can’t get you in. So if the stock rallies and goes to $10 before coming back down to $4 you will miss out of the run. That is the risk you take by using a limit order. However…

From my experience, you almost always have more than one chance to get in at the price you like. So I would never feel bad about using a limit order to buy any small-cap or penny stock. It will save you money 95% of the time.

Here’s to good investing,

James
March 9, 2006

A Simple Strategy to Improve Your Portfolio No Matter What the Market Does was originally featured in the Penny Sleuth.