Contents
- What are trading orders?
- Difference between an order and a trade
- Order types
- How to use trading order types
- In conclusion
What are trading orders?
In trading, you conduct transactions by sending instructions to your broker to buy or sell an instrument on your behalf; these are called, quite reasonably, “trading orders”. When trading online, the same principle applies, except that the order is placed over the internet through a trading platform.
This kind of instruction to your broker will normally be composed of three things.
- Whether you are buying or selling.
- The size of the trade in shares or, for forex, the kind of lot.
- The price at which the trade will be placed.
- The time the trade should be placed.
Though the mechanics of drafting an instruction, online or on paper, aren’t exactly complex, it is possible to make expensive, embarrassing mistakes. New investors, or those who are new to some trading platform, should probably execute a few demo trades to familiarise themselves with the process.
The difference between an order and a trade
A trade conducted in financial markets is, in principle, just like any other transaction in which goods or services are exchanged for money. The only distinction from (say) buying eggs at the farmer’s market is that the item in question is a financial instrument. A buyer pays the seller in cash, and ownership is transferred.
What makes financial markets different is that a trader needs a regulated, licensed entity – normally a broker – to actually place the trade on their behalf. Traders therefore send a formal instruction the broker regarding the trade, and this is called an order.
Order types
The simplest kind of order is just to buy a security at the cheapest currently available price or sell it for whatever it will fetch. There are only five types of orders that retail day traders use commonly, as outlined by Investopedia. With the advent of algorithmic trading, however, the number of order types is now almost infinite. Sophisticated investors like hedge funds routinely place orders with tens of inputs. These are then processed by algorithmic market makers at investment banks. That having been said, there are only five types of orders that retail day traders use commonly. These basic configurations also underlie more complicated kinds of orders.
Market order
A market order instructs a broker to buy or sell an instrument at the next available price – that is, as soon as a seller or buyer can be found. There is no specific price set when dealing with a market order, which may sound risky. However, unless there is a profound absence of liquidity, market orders are usually executed at or very close to the price available when the order was placed. It’s the simplest of all trading order types.
Limit order
A limit order tells a broker to buy or sell an instrument at a specified price or better. If this is not reached and the order cannot be matched with a seller or buyer, it is not executed. This implies that there is no guarantee that the order will be filled. Limit orders enable an investor to state exactly how much they are willing to buy or sell an instrument for. They do not need to be glued to their computers, waiting for their chosen entry or exit level to appear.
In addition, traders can set a specific expiry time for a limit order. The default condition is known as “good-til-cancelled” (GTC), which causes the order to remain open until executed as a trade.
Buy limit orders mean placing a trade at or below a defined price. Likewise, sell limit orders mean executing a trade at or above a defined price, perhaps to take profit.
Stop order
A stop order is used to enter or exit the market at a price less favourable than what exists at present. In the case of a buy-stop order, the order is placed above the current market price; conversely, sell orders are placed below the current market price. This is one of the most widely used trading order types for risk management.
The most common use of stop orders is a stop-loss order. This type of order is often used by traders as a means of risk management, enabling them to limit losses and sell a declining security in the event the market moves against them.
Stop losses are free to use and are an excellent way to protect your account against adverse and unforeseen developments, but we should be aware that they cannot guarantee your position every time. If the market suddenly becomes volatile and “gaps” (jumps from one price to the next without trading at the levels in between) beyond your stop level, it is possible your position could be forced to close at a worse level than requested. This is known as price slippage.
Stop price limit order
Stop quote limit orders are useful to either limit a loss or protect a gain on a security. It’s better to take a reasonable profit rather than hoping that a bullish trend will continue indefinitely; most investors prefer to cut their losses if their position drops below a certain level. Stop price limit orders combine the features of a stop quote order and a limit order.
A sell stop quote limit order specifies a price below the current market price. It comes into effect when the best available bid quote (what somebody is willing to pay for the security in question) is at or below the specified stop price.
A buy stop quote limit order is the opposite and is placed at a stop price above the current market price. It triggers if the national best offer quote (what somebody is willing to accept) is at or higher than the specified stop price.
Once this condition has been met, a stop quote limit order is effectively the same as a limit order, and the broker will buy or sell, as applicable, at the limit price specified by their client. As with stop orders, though, stop price limit orders may not be executed, as the market price can move past the specified limit price.
Trailing stop order
Traditional stop quote orders are fairly straightforward and spell out a number at which a security will automatically be bought or sold. In some circumstances, however, it is desirable to adjust the stop price depending on changes in the bid or offer price. The trail value can be specified as a fixed dollar amount or as a percentage. Once the calculated stop price is reached, the order activates and becomes a market order. Among all trading order types, this one adapts automatically as the market moves.
There is also something called a trailing stop quote limit order. This is similar to a traditional stop quote limit order; however, the stop and limit prices are adjusted to follow changes in the national best bid or offer for the security. Again, trail values can be fixed dollar amounts or percentages.
How to use trading order types
On a typical trading platform, the order ticket lists the four types of orders available for price entry: market, limit, stop, and stop limit. You will probably also see the two order types available to automate exiting the trade: TP for take profit and SL for stop loss.
The entry orders are specified in terms of price, which you can type in or, in some cases, select by dragging a caret on the vertical axis of the price chart. The exit levels can be set using a fixed price or by entering the number of pips away from the entry price.
For example, an investor may place an order to buy 10 shares of Tesla with a limit order at $600, a stop-loss at $500 and a take profit order at $1000.
In conclusion
While it is possible, at least in theory, to day trade successfully using only market orders, risk management becomes far simpler when you understand other order types. At a minimum, stop losses should be a cornerstone of your investment strategy. A large proportion of retail traders do so part-time, and even those who make a career out of it cannot watch the markets constantly. It simply makes sense to limit your exposure using the tools at your disposal.
