Guarding Against Market Gyrations

If ever there were proof of the perils of bad timing, it was in the three trading days between May 6, when the Dow plunged nearly 1,000 points, and May 10, when it jumped nearly 400 points by mid-morning.

Long-term buy-and-hold types can shrug these things off. But what about the poor folks who bet wrong on the plunge and missed the spike? Some traded at prices far less favorable than they’d expected.

This might be a good time for a refresher on trading techniques that can be used by stock and fund investors to avoid these pitfalls, and how those tricks can sometimes backfire. Market gyrations offer yet another reason for investors to favor exchange-traded funds over ordinary mutual funds.

The fastest and most common way to trade an individual stock is through a “market” order, in which the investor directs the broker to buy or sell immediately. You pay or receive the market price at the instant the order is executed.

Usually, this is pretty safe, as prices don’t shift all that much in the moments it takes to get a trade through the system, especially if you issue your own orders online rather than wait for a broker to do it for you. Market orders move very quickly because it’s not necessary to find a buyer or seller who specifies the same price you do.

Still, there is a risk you won’t get the price you had expected. And when markets are particularly volatile, you may end up buying or selling at a price you’d have rejected if you’d had a choice.

The solution is a “limit” order. A buyer orders a trade at or below a fixed level, a seller orders a trade at or above a limit. With limit orders, however, there is a risk the trade may not get executed at all, especially if prices are moving rapidly.

That may not matter if your stock is just bouncing around on an especially volatile day. But it can matter a lot if, for example, you want to sell, miss the price you’d hoped to get, and then have no choice but to issue a new sell order at an even lower price — lower than you’d have received with a market order. Similarly, a buyer using a limit order may miss the chance to buy and then face a price too high to be appealing.