The order type you use to place a trade can have a big influence on the outcome of the trade. Trade orders are instructions that are sent to brokers to enter or exit positions. While it can be very simple to enter and exit a position – push the “buy” button to get in and press the “sell” button when it’s time to get out – trading in this manner is both inefficient and risky. If you trade just using the buy and sell buttons, you can sustain losses from slippage and from trading without a protective stop loss order.
Slippage is the difference between the price you expected and the price at which the trade is actually filled, and it can be considerable and costly in both fast-moving or thinly traded markets. Certain order types let you specify exact prices for trades, which can minimize or eliminate the risks associated with slippage.
Protective stop loss orders are exit orders that are used to limit trading losses by creating a “line in the sand” past which a trader will not risk any more money. A stop loss order automatically closes out a losing trade at a pre-determined price level. A protective stop loss order can be placed in the market as soon as a trade is entered. This can be especially important in fast-moving markets where a trader’s loss limit could be reached within seconds of getting filled on an order entry.
Because trading requires a great deal of precision, the types of orders that you use can have a profound effect on your trading strategy’s performance. In this section, we’ll look at the various types of orders you can use while trading.
Long and Short Trades
First of all, it’s important to understand the difference between long and short trades. A long trade, or long position, is entered if you expect to profit from rising prices. This is the “standard” trade direction, and losses from long trades are considered limited (although they can still be large) because price can only go as low as $0 if the trade moves in the wrong direction.
A short trade, or a short position, is entered with the expectation of profiting from a falling market. Using a margin account, you can enter a short position by borrowing a stock, futures contract or other instrument from your broker. Once price reaches the target level, you buy back the shares (or contracts), or buy to cover, to replace what you originally borrowed from your broker. Losses from short positions are considered unlimited because price could theoretically continue rising indefinitely.
A market order is the most basic type of trade order. It instructs the broker to buy (or sell) at the best price that is currently available. Order entry interfaces and many apps usually have “buy” and “sell” buttons to make these orders quick and easy. Typically, this type of order will be executed immediately. The primary advantage to using a market order is that you are guaranteed to get the trade filled.
If you absolutely need to get in or out of a trade, a market order is the way to go. The downside, however, is that market orders don't guarantee price and they don't allow any precision in order entry, which can lead to costly slippage. You can help limit losses from slippage if you use market orders only in markets with good liquidity.
A limit order is an order to buy (or sell) at a specified price or better. A buy limit order (a limit order to buy) can only be executed at the specified limit price or lower. Conversely, a sell limit order (a limit order to sell) will be executed at the specified limit price or higher. Unlike a market order where you simply press “buy” and let the market select the price, you must specify a price when using a limit order.
While a limit orders prevents negative slippage, it does not guarantee a fill. A limit order will only be filled if price reaches the specified limit price, and a trading opportunity could be missed if price moves away from the limit price before it can be filled. Note: the market can move to the limit price and the order still may not get filled if there are not enough buyers or sellers at that particular price level.
|Enter a limit order to buy at or below the current bid; enter a limit order to sell at or above the current ask price. Image created with TradeStation.|
A stop order to buy or sell becomes active only after a specified price level has been reached (the “stop level”). The placement of stop orders differs from that of limit orders: a buy stop order is placed above the market, and a sell stop order is placed below the market.
Once the stop level has been reached, the order is automatically converted to a market or limit order and, in this sense, a stop order acts as a trigger for the market or limit order. Consequently, stop orders are further defined as stop-market or stop-limit orders: a stop-market order sends a market order to the market once the stop level has been reached; a stop-limit order sends a limit order.
|A buy stop order is placed above the market; a sell stop order is placed below the market. Image created with TradeStation.|
A trailing stop is a dynamic stop order that follows price in order to lock in profits. A trailing stop incrementally rises in a long trade, following price as it climbs higher. In a short trade, a trailing stop falls as it follows price downward. You have to define the magnitude of the trailing stop, either as a percentage or a dollar amount, defining the distance between the current price and the trailing stop level. The tighter the trailing stop, the more closely it will follow price. Conversely, a wide trailing stop will give the trade more room since it will be further from price.
Stop Loss Orders
Perhaps the most common application for a stop order is to set a risk limit for a trade, or a stop loss. A stop loss order is set at the price level beyond which a trader would not be willing to risk any more money on the trade. For long positions, the initial stop loss is set below the trade entry, providing protection in the event that the market drops. For short positions, the initial stop loss is set above the trade entry in case the market rises.
Conditional orders are advanced trade orders that are automatically submitted or canceled if specified criteria are met. Conditional orders must be placed before the trade is entered and are considered the most basic form of trade automation. Two common conditional orders are the order cancels order (OCO) and the order sends order (OSO).
|Examples of OCO applications. Image courtesy PowerZone Trading.|
In addition to market, limit, stop and conditional orders, you can also specify how long an order will be in effect; that is, how long the order will remain in the market until it is canceled (assuming it's not filled). Order durations include:
- Day – automatically expires at the end of the regular trading session if it has not been executed.
- Good-Til-Canceled (GTC) – remains active until the trade is executed or you cancel the order. Brokers usually cancel GTC orders automatically if they have not been filled in 30-90 days.
- Good-Til-Date (GTD) – remains active until a specified date unless it has been filled or canceled.
- Immediate-Or-Cancel (IOC) - requires all or part of the order to be executed immediately; otherwise the order (or any unfilled parts of the order) will be canceled.
- Fill-Or-Kill (FOK) – must be filled immediately and in its entirety or it will be canceled.
- All-Or-None (AON) - Similar to an FOK, an AON order will be canceled if the order cannot be filled in its entirety by the end of the trading session.
- Minute – expires after a specified number of minutes have elapsed.
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