Types of Orders

When you are buying and selling securities, you can place different types of orders to improve your execution prices. The incremental size of an order is also important. Using a round lot usually means that the number of shares traded is 100 or a multiple of 100. For very cheap stocks (“penny stocks”), a round lot may be 500 or 1,000 shares; for high-priced shares, a round lot could be considered 10 shares. These 10-share round lots are referred to as cabinet stocks. Berkshire Hathaway A stock is a good example of a cabinet stock. It was currently trading around $110,000 per share (May 11, 2007). This is the most expensive stock on the NYSE. An odd lot for most cabinet stocks consists of a trade of between 1 and 9 shares. On regular- priced shares, an odd lot consists of between 1 and 99 shares; for very cheap stocks, an odd lot consists of fewer than 500 shares. Investors trading in odd lots generally pay more to trade than investors trading in round lots. The commissions paid in order to execute odd-lot trades may be higher.

Orders for stocks in excess of 10,000 shares are called block trades. These orders, typically placed by institutional customers, are handled in a variety of ways. Commissions are much lower than for normal trades, and orders are executed instantaneously. By knowing the types of orders to use and how they are executed, you might be able to lower your transaction costs and avoid any misunderstandings with your brokers.

Table 7-2
Examples of Level 2 Quotes and What They Mean
Some online brokerage firms provide level 2 quotes for OTC stocks for their online clients. The following example illustrates the quotes offered by market makers and ECNs for a particular stock. Many actively traded stocks could have as many as 40 market makers. Microsoft, for example, might have 20 to 40 market makers.

With level 2 quotes, a market buy order for a particular stock receives each market maker’s or ECN’s best bid offer. In this example, the best offer (ask) price is $19.26 per share for this particular company from ECNs 1 and 4. A market order to sell transacts at the best bid price, which is from ECNs 1 and 3 at $19.25 per share.
When a market order is entered, it is executed at the best price and continues to be filled incrementally until the order is completed. For example, a market order to buy 5,000 shares of the stock listed above would be transacted as follows:
2000 shares from dealer 1 at $19.26 per share
2000 shares from dealer 4 at $19.26 per share
500 shares from dealer 3 at $19.27 per share
500 shares from dealer 2 at $19.27 per share
An investor also can place an all-or-none order to make sure that it fills at the same price. The identity of each market maker or ECN is available to the investor. The size indicates the inventory that is available.

Table 7-3
What Spreads Disclose
Stock spreads are determined by their bid and ask prices. Bid and ask prices are determined in some ways by supply and demand for the stocks but more specifically by the availability of the stock at particular prices. Bid and ask prices change rapidly in real time. Paying attention to the bid and ask sizes (the amount of stock available from each market maker) of each stock can provide more information about the supply and demand for the direction of the stock price. Spreads have narrowed because of the greater pricing transparency gained from access to realtime quotes through technology. The result of having narrower spreads is better execution prices. For example, the reduction in spreads from $0.03 to $0.02 per trade of 1,000 shares results in a $10 savings. If you make 100 trades per year, the total saving is $1,000. These savings can meaningfully increase returns on your portfolio. You can draw these inferences about spreads:
* A wide spread indicates an illiquid stock.
* A narrow spread indicates a liquid stock.
Use limit orders when buying and selling stocks to specify the exact purchase or sale price. With a market order, the purchase (or sale) price could be higher (or lower) than the ask (or bid) price.
The bid and ask size also indicates the relative strength or depth of the bid and ask prices. When the supply of a stock (the ask size) is larger than the demand for the stock (the bid size), the short-term price indication is that the stock price will fall. Conversely, if the ask size is smaller than the bid size, the short-term price of the stock is pressured upward. The following quote is used as an example to illustrate the price direction using the bid and ask size:

In this example, the bid size is larger than the ask size, indicating greater demand for the stock than the supply. In other words, the short-term price is headed upward. You can use the bid and ask size to assist in the determination of whether to use a market or limit order.

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