When the market drops sharply, you're generally better off licking your chops over sudden bargains than gnashing your teeth over temporary losses. As the market plunged on May 6, visions of purchase orders danced in my head -- but alas, I couldn't place a trade in time to profit before the market corrected itself. If I'd only set up limit orders on the stocks I wanted, I might have entered May 7 with more profits in my pocket.
Market limits
A market order buys or sells stocks at the going price. But a limit order instructs your broker to buy or sell a given stock only at a set price or better. I've generally used market orders in my own investing, rather than wasting time or chances on limit orders. After all, if the stock never moves into the range I've specified, a limit order could keep me out of that investment altogether.
However, May 6 pointed out market orders' limitations. If I'd placed a market order to sell shares of Boston Beer (NYSE: SAM ) at the wrong time that day, when the stock briefly fell from nearly $60 to a mind-boggling penny per share, I might have ended up selling for far less than I expected. That would have been a shame, given the company's rising profit margins and the prospect of tax relief for small brewers.
Many trades that happened during that problematic freefall period ended up canceled. But less extreme free falls do happen from time to time, making market orders a potential problem, especially for volatile stocks.
Limit upsides
I'd think twice before placing a limit sell order on a stock I own. One volatile day could inadvertently boot me out of a strong company. However, limit buy orders can be handy.
Procter & Gamble (NYSE: PG ) has probably earned a spot on many people's watch lists, thanks to its steadiness, its massive brands, and its long dividend-hiking history. At its recent price around $60, its P/E of less than 15 is well below its five-year average of 20. Still, some investors might want to wait for an even better price.
Only the most fleet-fingered and eagle-eyed souls could have bought shares during their quick plunge May 6. But if you'd had a limit order to buy P&G when it fell to, say, $50, you might have walked away with shares at a discount.
I've rounded up a few other stocks that moved sharply that day, each rated with four or a maximum five stars by our CAPS community of investors. With the right limit orders, you might have owned them:
- Accenture (NYSE: ACN ) enjoys steadily rising profit margins, a return on equity topping 50%, and consulting and outsourcing businesses that stand to benefit as our economy recovers.
- Hansen Natural (Nasdaq: HANS ) has refreshed its profit margins since 2008, and it generates a return on equity greater than 35%. As Americans get more stressed-out and more sleep-deprived, energy drinks and other beverages purported to be healthier than plain soda pop should become even more appealing.
- Linn Energy (Nasdaq: LINE ) and its 10%-plus dividend yield might have made the watch lists of investors willing to stomach the tumultuous gas and oil markets.
Are there any stocks on your watch list for which you'd be willing to wait for a more attractive price? If so, a limit order can ensure that being busy, distracted, or simply unaware of a market drop won't keep you from capitalizing on an opportunity.
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