When an investor wants to buy or sell a share of common stock, the price and conditions under which the order is to be executed must be communicated to a broker. The simplest type of order is the market order, an order to be executed at the best price available in the market.
The danger of a market order is that an adverse move may take place between the time the investor places the order and the time the order is executed. To avoid this danger, the investor can place a limit order that designates a price threshold for the execution of the trade. The key disadvantage of a limit order is that there is no guarantee that it will be executed at all; the designated price may simply not be obtain- able. The limit order is a conditional order: It is executed only if the limit price or a better price can be obtained.
Another type of conditional order is the stop order, which specifies that the order is not to be executed until the market moves to a designated price, at which time it becomes a market order. There are two dangers associated with stop orders. Stock prices sometimes exhibit abrupt price changes, so the direction of a change in a stock price may be quite temporary, resulting in the premature trading of a stock. Also, once the designated price is reached, the stop order becomes a market order and is subject to the uncertainty of the execution price noted ear- lier for market orders. A stop-limit order, a hybrid of a stop order and a limit order, is a stop order that designates a price limit. In contrast to the stop order, which becomes a market order if the stop is reached, the stop-limit order becomes a limit order if the stop is reached. The stop- limit order can be used to cushion the market impact of a stop order. The investor may limit the possible execution price after the activation of the stop. As with a limit order, the limit price may never be reached after the order is activated, which therefore defeats one purpose of the stop order—to protect a profit or limit a loss.
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Types of Orders
November 13th, 2010TECHNICAL ANALYSIS
November 12th, 2009Technical analysis constitutes an alternative approach to trading than that provided by arbitrage and fundamental analysis. The underlying rationale for technical analysis is that markets are human systems and that prices of instruments traded in these markets are determined to a large extent by mass psychology.
Fundamental equity analysts work alongside economists and technical analysts. They respect the methods used by economists while retaining a healthy skepticism about their forecasts. Most are duty bound to mistrust the methods used by technical analysts but, if they are honest, accord their conclusions with a degree of respect. A fundamental analyst will hesitate before putting out a report advocating a strong buy on a stock where the technical analyst says that technical indicators are strongly indicative of a likely sharp stock correction. Among the features of technical analysis are the following:
Prices move in cycles, and in cycles within cycles. Prices move in a series of “waves” and trends can be distinguished from cyclical effects. Specific price levels can be identified that act as resistance levels (for rising prices) or as support levels (for falling prices).
Identifiable patterns can be recognized in prices tracked over time and likely turning points can be identified in advance.
Specific factors that technical analysts take into account are:
The current market price versus moving averages of prices over defined time intervals, typically 30 days, 90 days, 180 days and one year.
Daily opening and closing prices and intra-day highs and lows. Charts showing these are referred to as “candlestick” charts by virtue of their appearance.
Trading volumes and whether these are rising or falling.
Technical analysis is diametrically opposed to widely accepted mainstream dogma on market efficiencies which claim that in efficient markets price changes are essentially random and that it is impossible to predict future prices from historic prices.
Technical analysis is better at explaining past price behavior than predicting future price movements (isn’t that always the way). It is easier to see price patterns with the benefit of hindsight and most forecasts are qualified in some way. A support level, for example, may be tested. If the support level is breached then technical analysis can be used to identify the next support level. If on the other hand it is tested but fails to break the support level this may lead to a new resistance level. If technical analysis provided a guaranteed way to make money then there would be more technical analysts working for their own account and less employed by brokerages and speculators.
Most financial academics studiously avoid any mention of technical analysis, treating it much as scientists would treat alchemy. A variation on Shakespeare comes from David Mamet, an American dramatist: “The poker player learns that sometimes both science and common-sense are wrong; that the bumblebee can fly; that, perhaps one should never trust an expert; that there are more things in heaven and earth than are dreamt of by those with an academic bent.”