4 Trade Execution Mistakes You Need to Avoid

Trade execution is one of the most mysterious parts of the investing world – few individual investors concern themselves with what’s happening to their stocks after they click the “Order” button. But that could be a big mistake, especially for penny stock investors… Here’s a look at four trade execution blunders that you need to avoid.

First, let me explain a couple things about trade execution. Every time you execute a trade – that is, buy or sell any financial instruments – you’re initiating a complex series of events that are designed to ensure that your order gets filled quickly and efficiently. But don’t think that the order you submit on your broker’s website starts flashing on screens at the NYSE as soon as you submit it. Instead, your broker acts as an intermediary, deciding which of their channels they’ll task with filling your order.

That means that all brokers aren’t created equal – and when it comes to trade execution, your mileage may vary.

Two investors could execute an order at the exact same time and get filled at completely different stock prices depending on the latency at the broker and the method they use to get the shares you requested. For that reason, which broker you choose is a big deal. (To help you pick the best broker, we’ll be publishing an updated Broker Guide for 2010 soon – stay tuned.)

But that’s not to say that brokers are allowed to drag their feet in filling an order. The SEC requires that brokers provide their clients with “best execution”, which essentially means that a broker needs to fill your order at the best price possible at the time.

Even with duty of best execution, it’s easy to fall victim to one of four cardinal trading blunders. Here’s everything you need to know to avoid them…

1. Don’t Bother with Extended Hours Trades

While the markets are open from 9:30 a.m. until 4:00 p.m. Eastern, the advent of extended hours trading in the late 1990s has helped traders extend their profit taking opportunities before and after the traditional trading session. But as tempting as it may be to take a position in a stellar stock after hours, after hours (AH) and pre-market trading should generally be avoided by small-cap investors.

The main reason for that is a lack of liquidity: with fewer market participants buying and selling shares, a smaller volume of trades can have a disproportionately large impact on a stock’s share price. And because professional and institutional investors avoid extended hour trading, price discipline generally goes out the door when the market’s not in cession – a factor that’s lead some trading message boards to refer to after hours trading as “amateur hour” trading.

Generally, extended sessions give a good indicator of the direction of the day’s trades, but they’re often way off on the size of a move. Wait until regular session before buying or selling to avoid the price swings and volatility.
2. Don’t Use a Market Order on an Illiquid Stock

In the penny stock world, illiquid stocks are par for the course. Whether it’s because of their small size, an underappreciated business model, or a lack of institutional coverage, when shares of a company aren’t being traded in large numbers the potential for volatile price action is there.

To be sure, illiquid stocks can present some of the best investments out there – after all, who wouldn’t want to get into a smart position before the rest of Wall Street catches on? But if you’re buying shares of an illiquid company, don’t you dare use a market order.

Market orders are essentially orders to buy shares of a stock at market price, whatever that may be. And although market price may be tightly bounded in a stock like General Electric (NYSE: GE), the prices you see when you buy shares can move rapidly with small, thinly traded penny stocks. Since a market order is all but guaranteed to execute, the chances of getting filled at a bad price are very unappealing. Use a limit order instead – while you may not get filled right away, you’ll have control over the price you pay.

3. Don’t Use Bad Data Sources

It may seem surprising that investors use free investment research websites like Google Finance or MSN Money to get their trading information, but it happens regularly. While these sites are absolutely great for getting quotes on the fly, some data sources are often delayed, and they’re not recommended for trade decision-making. The kicker is that as an investor, odds are that you have a premium stock research tool available to you free of charge: your broker’s website.

Use real-time services from your broker when making decisions that put your hard earned money on the line.

4. Don’t Trade Small Order Sizes

When you’re deciding how many shares of a stock you want to buy, don’t make the critical mistake of buying too few. That’s because with commissions the amount of gains you need to make just to break even could be unrealistic. If your broker charges $10 per trade, you’re paying $20 to buy a stock then sell it off when the time is right – that means that if you invest $100 in that stock, you need to make at least 20% gains just to break even! Increase that investment to $500, and you only need to make more than 4% to record a profit on the stock. At $1000, your stock only needs to make 2% to be a winner. While investing a tiny position might seem like a financially prudent thing to do, it could actually end up being an expensive mistake.

With fickle markets swinging stocks enough these days, don’t predispose your positions to losses – analyze your trade size before you place it.