Daily Stock Market Equity and Options Trading Commentary

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Tuesday, December 16, 2008

Why I Never Set Market Orders and Rarely Set Limit Orders

Tonight I am sharing why I never set market orders and rarely set limit orders. The first rule of serious investing is never set market orders! Never set market especially when the volume on the stock is light... If the last price of a stock was $8.50 and the current bid is $8.25 and current ask is $9 and you place an order to buy at market, you will buy at $9. I would suggest putting a limit order a penny to 5 above the current bid, this will give you the highest bid and you might be able to bargain with the lowest "asker". So why not use a limit? When trying to buy a stock I'll use the PUT option. If a stock is at 50 and I wanted to pay 45, I will then simply sell to open a put contract at the 45 strike. I will then get a premium, and if the stock is below the price I want to pay, when the contract expires, I get the stock at the price I would have picked it up at anyway (price I would use to place the limit order). This helps cost average down your shares, and gives you a chance to make "free money" if the option expires above the strike. Obviously you wouldn't use this strategy if you were buying less than 100 shares, or if you absolutely "needed the stock today" in your portfolio. I have been using this strategy to purchase my shares and I find it has been working well. If you say "well you could really get burned, because it is like becoming the insurance company for a particular stock", I would argue. Say a stock is at 50 and then goes to 38 and you sold the 45 put for a $300 premium or $3 a share(when the stock was at 50), then you are down $4500 (price paid for stock) -$3800(current value of stock) - $300 (premium received for stock) or down a total of $400, but if you put a limit in for $45 (when the stock was at 50) and you filled your order, and the stock then goes to $38 you lose $700. The trade-off is: not owning the stock today versus money in your account today, with the chance of never getting the stock at all. This is my strategy for buying all of common shares.

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