Ask Mike:
How should I get started and how do I use limit orders?

Question:

Hello Mike,

I started my subscription to the 'ETF Total Return Portfolio' yesterday. I would like to match you trade-for-trade.

Currently, I don't own any ETFs -- so I'll be starting with the proverbial blank slate.

Looking at the ETF Total Return Portfolio Worksheet (as of 12/11/2006), I see that your advice is: 'If you are planning to match this Portfolio trade-for-trade, we recommend you only add new positions as we add new positions, or not start out with any existing positions with a current price more than 2% from our basis'.

So, I assume that the bottom line is for me to wait, and not to start adding any ETFs to my portfolio until you recommend a new position. Is my assumption correct?

And when I enter a position, you recommend using a limit order. Can you be a little more specific about this? My experience up till now (ha!) has been to use only market orders to enter positions, so I'm not experienced in the mechanics of placing limit orders.

Thanks,

Barry from Albuquerque

Mike's Response:

Hi Barry,

Thank you! It is good to have you on board.

If you want to match me trade-for-trade, then you really should only buy when I buy buy the same proportional number of shares (for the ETF Total Return, that would be 10% of your investment basis in each of the 10 positions) and, use the same limit order that I use.

So, you are right that the best way to get in is to wait until I fill an open position.

With regard to market versus limit orders... There is nothing wrong with using a market order when the market is open, assuming the spread between the bid and ask is only a penny or two. A market order basically means you will pay the highest price possible (the asking price).

A limit order means you will only pay the exact price that you set, or lower, whichever is the lowest. So, if a stock has a bid/ask of $30.00/$30.10, and you put in a limit order of $29.00 your order will not get filled unless the price drops to $29.00. This could mean that you will not get that stock. You can also set a GTC (Good Till Close) date/time for your order, which means you want the order to stay active for some period of time.

I decide what stocks/ETFs I want to add to a portfolio on the weekend, before the markets open on Monday. I almost always use limit orders with a GTC through the upcoming Friday. Depending on the strength of the market, I may enter a limit order that is higher than the most recent closing price. This means I really want this stock and am willing to pay up for it a bit. In these cases, if a stock closed at $30.00 and I really want the stock (or ETF), I might place a limit order for $31.00. If the stock opens at $29.00, I will get it at $29.00. If it opens at $31.01 or higher, I will not get the stock unless the price drops back to $31 or below.

If I believe the market will be weak for the upcoming week, I might very well enter my limit orders with a significant discount to the Friday close. Using the same example, I might put a limit order on for the $30.00 stock at $29.50 or even $28.00, if I really don't mind if I don't get filled but I do want the stock if I can buy it at a discount.

Limit orders give investors a lot of flexibility for the entry point. They are a great tool for playing on the overall sentiment of the broader market. Strong markets mean that you will not get many discounts and may have to pay up a bit to get a stock. In a weak market, you can often get a great stock or ETF at a discount.

This is why my Bull/Bear Rating is so important. It gives us an idea of whether we are bargain hunting or not. Using limit orders can easily increase your annual return by 1% to 2% which often is generally enough to more than pay for the cost of trading fees.

Best regards,

Mike