Order Types

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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 usually have “buy” and “sell” buttons to make these orders quick and easy, as shown in Figure 1. Typically, this type of order will be executed immediately. The primary advantage to using a market order is that the trader is guaranteed to get the trade filled. If a trader absolutely needs to get in or out of a trade, a market order is the most reliable order type. The downside, however, is that market orders do not guarantee price, and they do not allow any precision in order entry and can lead to costly slippage. Using market orders only in markets with good liquidity can help limit losses from slippage.

Ideally, a market order to buy is filled at the ask price, and a market order to sell is filled at the bid price. It is essential to remember, however, that the last-traded price is not automatically the price at which a market order will be executed. This is especially true in fast-moving or thinly traded markets.

For example, a trader may place a market order to go long 1000 shares of ABC stock when the best offer price is currently $20.00 per share. If other orders in the queue are executed before this trader’s order, the market order may fill at a higher price. It is possible, also, that parts of the order will execute at different prices. In this example, half of the order might execute at the best offer price and the other could fill at a higher price. A market order does not guarantee price – it only guarantees a fill.

Use a limit order to guarantee a price. A limit order allows precise order entry. A limit order is appropriate if getting a specific price is more important than getting filled.

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 the trader can simply press “buy” and let the market “choose” the price, a trader must specify a desired 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 (depending on the trade direction) at that particular price level.

Limit orders allow traders to enter and exit trades with precision; however, they must be entered correctly to ensure that they accomplish the goal of improving price – that is, to get a specified price, or better, on a trade execution. It is important to be on the correct side of market: when entering a buy limit order, the trader must specify a price that is at or below the current bid; for a sell limit order, the specified price must be at or above the current market ask.

The price ladder in Figure 2 demonstrates this concept.

Traders use limit orders to improve price and to take advantage of pullbacks in price. Figure 3 shows a five-minute chart of the e-mini S&P 500 futures contract, with a limit order waiting to be filled if the price drops back down to $1421.00. An OSO order (discussed in the Conditional Orders section of this tutorial) is attached that will automatically send profit target and stop-loss orders if the limit order to buy is filled (the profit target and stop-loss orders appear on the price chart as gray horizontal lines; the price level for the limit order to buy is blue).

To illustrate how important it is to place the order on the correct side of the market, imagine placing a limit order to buy above the current market price. Using the example in Figure XX (where Alcoa is trading at $8.78), the trader enters a limit order to buy at $8.92 (above the current price). This order will be filled immediately (the market does not care if you don’t know how to use a limit order) and the trader may consequently be in a losing position (since the current price is below the trade entry). A limit order is always used to get a certain price or better, and must be placed on the correct side of the market.

Note: Use a stop order to trigger a market or limit order once a specified price has been reachedA stop order is appropriate when it is important to confirm the direction of the market before entering a trade.

A stop order to buy or sell becomes active only after a specified price level has been reached (the “stop level“). Stop orders work in the opposite direction of limit orders: a buy stop order is placed above the market, and a sell stop order is placed below the market (see Figure 4). Once the stop level has been reached, the order is automatically converted to a market or limit order (depending on the type of order that is specified). 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. Stop-market orders are perhaps the most commonly used since they are typically filled more consistently.

Since a buy stop order creates an order to purchase a stock (or other trading instrument) above the current price, some traders may wonder why anyone would want to enter a trade at a worse price than the current market price. This is a good question. A buy-stop order will trigger the market or limit order onlyif price reaches the stop level, allowing traders to challenge price to reach a certain level. If price reaches the stop level, it can provide confirmation regarding the direction of the market. Traders often use key levels, such as support and resistance or Fibonacci levels, when choosing stop levels. Figure 5 shows a buy stop market order that will fill once price touches the $1425 price level on the e-mini S&P 500 futures contract.

Perhaps the most common use of 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.

Another application of a stop order is the trailing stop. A trailing stop is a dynamic stop order that follows price in order to lock in profits. A trailing stop incrementally increases in a long trade, following price as it climbs higher. In a short trade, a trailing stop decreases as it follows price downward. Traders must define the magnitude of the trailing stop, as either 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, as it will be further from price.