Nasty surprises

‘I didn’t order that!’ – or how to avoid a nasty surprise

You probably remember the Champions League final 1999 in Barcelona between Bayern Munich and ManU. With two goals in the last seconds, ManU turned the game upside down and won the trophy.

As it was bad enough for the german players or fans, for one Bayern-assistant, it was even worse. He left the bench shortly before the final whistle, while his team was still ahead, and went inside the huge ‘Camp Nou’ stadium to the team’s locker room.
There, he picked up champagne and box containing a set of pre-fabricated caps with the claim ‘Bayern Munich, Champions League Winner 1999’.
You can imagine the nasty surprise, when he returned to the pitch and learned the new reality. ‘I went in as a winner and came out as a looser’ he later described the situation.

A nasty surprise is looming in many parts of life. In stock markets, a supposed winner becomes a sure looser, if he places the wrong kind of order to his bank or broker.

I can tell you that first hand, since I made that costly mistake. After some examination of a stock, I called my bank (there was no online broker around that time) and placed a ‘market order’ for 100 shares of a small company, who noticed 55 that morning. I felt good, I would be the winner.
2 days later, the confirmation of the trade was in the mail. The bank did was I ordered, but, to my nasty surprise, bought the stock at over 60 a share. Angry, I called again, but the bank made it clear, it was my fault – I placed the wrong kind of order.

If you place a ‘market order’, the bank will buy to the next available market price. This price can be much higher than you think. Why? Because if nobody wants to sell 100 shares at 55 the bank is looking for a match above this level. In my case they had a sell-offer at 61 in the order book and made the trade. A few days later, the stock was traded at 55 again, I was the looser.

A ‘market order’ should only be placed in highly liquid stocks and when you want an immediate execution.

Instead of a ‘market order’ you better place a ‘limit order’. That gives you the option to determine the maximum price you’re willing to pay for a stock. The ‘limit order’ is also the right choice when selling. You can indicate the minimum price you agree to sell.

You want buy a position for, let’s say, 90 a share, and you intend to spend the next three weeks at the Black Sea without checking the markets all day.

What happens, if the market crashes, while you’re on the water-scooter? To avoid huge losses, you could place a ‘stop-loss’ order, usually about 10% below purchase price to limit the possible damage. If the market price of you position falls to 81, your ‘stop loss’ transforms into a ‘market order’ and your stocks will be sold immediately.

But the better option, I would advise to work with, is an order type called ‘trailing stop’. Thereby you define a fix amount or a percentage of losses, you are willing to swallow.

In our example, I would set these values at 10% or 9 bucks. The difference to a simple ‘stop loss’ is that a ‘trailing stop’ is flexible – but only to the upside.
This advantage is known at the markets as ‘cut the losses and let the profits run.’ If your stock rises from 90 to 95, then the ‘trailing stop’ is moving with. He still comes to effect, when the stock looses 10% or 9 bucks, but this is now calculated from that higher market-price.

With regard to the validity of an order, there is usually one of the following order-restrictions to add

FOK – Fill or Kill
Immediate and complete execution or the order is cancelled.

GFD – Good for Day
These orders were deleted at the end of the trading day.

GTD – Good till Date
The order is valid until the indicated date.

GTC – Good till Cancel
Order is executed till you cancel over a period of max 90 days.

Ultimo
The order is valid till the end of the current month.

There are several other options who may vary from marketplace to marketplace.
I advise you to check with your bank or broker, before you place any order.

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Why so many highly paid mutual-fund-managers do a terrible job at your expenses is the subject of the next chapter: http://www.theleader.ro/a-much-better-alternative/