What Is a Discretionary Order?

A discretionary order is a conditional order placed with some latitude for execution. More broadly, a discretionary order is one where a broker or other financial markets professional can place and work an order without explicit acknowledgement from the customer. Discretionary orders help to improve the chances of order execution while still also allowing the investor to place certain conditional constraints.

How a Discretionary Order Works

Discretionary orders can broaden the specification of standard types of conditional orders to give an order a higher likelihood of execution.

Standard types of conditional orders can include an additional discretionary component. The discretionary component is commonly added to limit orders and stop loss orders. The discretionary component is a basic order provision that allows the investor to include a discretionary amount with their order. Thus, if a broker is a given a limit order with discretion, the broker may choose to change the limit price in response to market activity and liquidity when the order is received.

Discretionary orders can be placed through electronic trading systems or with a broker. In either case the investor specifies with a broker-dealer a conditional order with a discretionary amount. The discretionary amount is typically quoted in cents and gives the order some additional latitude for being executed beyond the standard conditions. These orders are viewed as special orders by broker-dealers who monitor them for submission. Broker-dealers will seek to submit orders based on the best price for the customer.

Discretionary orders are subject to broker-dealer allowances. If offered they can usually be added to all types of orders. In some cases an investor may add a discretionary amount to a single day order. Discretionary amounts can also be added to good 'til canceled orders which remain open indefinitely unless canceled by the investor.

Key Takeaways

  • Discretionary orders are those where a broker has some latitude in working the order on behalf of a client, without their express acknowledgement of each nuance.
  • Discretion most commonly accompanies conditional orders such as setting the limit price in response to changing market conditions.
  • Discretionary orders are also a key component of discretionary investment management, whereby a broker or advisor trades on behalf of a client without getting their input on every action.

Discretionary Order Examples

Many investors choose to add a discretionary amount to standard buy and sell limit orders. Limit orders are the most basic type of conditional order allowing an investor to choose a specified price for which they seek to buy or sell a security. Buy limit order prices will be below the market price and sell limit orders are above the market price.

In a discretionary buy limit order, an investor would specify a below-market price for execution. This investor would also specify a discretionary amount either through their trading system or with their broker directly. If an investor placed a buy limit order of $20 on a stock priced at $22 with a 10 cent discretionary amount, then it means they seek to buy the security at $20 but would permit a buy order price of $20 to $20.10. If the price falls to $20.10, this order would be submitted and executed for the investor.

In a discretionary sell limit order, an investor would specify an above-market price for execution. This investor would also specify a discretionary amount with their order. If an investor places a sell order at $24 on a stock trading at $22 with a 10 cent discretionary amount, then the order could be submitted and executed at a selling price of $23.90 or higher.

Discretionary Investment Management

Discretionary investment management is a form of investment management in which buy and sell decisions are made by a portfolio manager or investment counselor for the client's account. The term "discretionary" refers to the fact that investment decisions are made at the portfolio manager's discretion. This means that the client must have the utmost trust in the investment manager's capabilities. Discretionary investment management can only be offered by individuals who have extensive experience in the investment industry and advanced educational credentials. Discretionary investment management is generally only offered to high-net-worth clients who have a significant level of investable assets.

Clients will maintain a discretionary account—an investment account that allows an authorized broker to buy and sell securities without the client's consent for each trade. The client must sign a discretionary disclosure with the broker as documentation of the client's consent. A discretionary account is sometimes referred to as a managed account; many brokerage houses require client minimums (such as $250,000) to be eligible for this service, and usually pay between 1% and 2% a year of assets under management (AUM) in fees.