There are several basic order types when trading. Understanding the order types, and when to use them, is crucial to trading success as the wrong order type at the wrong time will likely mean missing out on a great trade, paying too much, not being able to get out of a trade, or receiving less than you could have.
There are many advanced order types, but most traders will only need a few variations of the market, limit, and stop orders. I use several combinations of these orders types.
Below, I’ll go through what these order types are, and when it would be appropriate to use them. I will use shares or stocks for illustration purposes, but the order types are applicable to other markets, such as forex and futures.
Market Buy or Sell Order
This is the most basic order if you want to get into or out of a trade quickly. A market order takes whatever price is available. There is limited liquidity at each price level, so market orders are susceptible to slippage. Slippage is not getting the price expected. For example, if the bid/ask is $25.66/$25.69, and the ask only has 100 shares posted, if you are trying to by 500 shares the first 100 will fill at $25.69, and the other 400 may fill at $25.70 (100), $25.72 (200) and $25.75 (100). Thus the trader ends up paying more than the $25.69 ask price.
A market buy will take shares from the ask, at the lowest price where liquidity is available. It will keep buying at higher prices until the order is filled.
A market sell will take shares from the bid, at the highest price where liquidity is available. It will keep selling at lower prices until the order is filled.
I very rarely use market orders. I use limit orders instead of market orders. Only use a market order if you need in or out very quickly and have little regard for the possible price you will get. In high volume stocks, slippage is typically minimal. In low volume stocks, slippage can be substantial with market orders.
Limit Order Buy or Sell
A limit order sets a cap on what price you buy or sell at. For example, a buy limit is saying you will only buy at or below a certain price. A $25.25 limit buy order means the order will only execute if the price trades at $25.25 or below. The order is sitting there and will be filled if someone is willing to sell at$ 25.25 or below. It will be filled at $25.25 unless the order is open and the price gaps down and opens the next day below that level. If the price opens at $25, the order will fill at $25 (because it is below $25.25).
A limit sell at $45.50 means only sell at $45.50 or above. The order is sitting there and will be filled if someone is willing to buy at $45.50. It will only fill above $45.50 if the order is open and the price gaps through $45.50 and opens the next day at a higher price. If it opens at $48, the order will fill at $48.
A limit buy is used to control how much is paid. It is useful for setting trades in advance. For example, a stock may be trading at $50, but an investor wants to buy it if it drops to $45. They could set a limit buy at $45. If the price reaches $45, they will be filled. No need to screen-watch constantly.
A limit sell is useful for getting out of a long position at a profit target. For example, assume a trader enters a stock at $25 thinking it will go to $35. They can set a sell limit at $35. If the price reaches $35 their shares will be sold and they will have made a nice profit.
You can also use limit orders like a market order, but with a capped price. For example, let’s say you want to buy a stock right now. The current ask is$25.75 with 100 shares. But you want to buy 1,000! Instead of using a market order which will give you a price you don’t know, you could use a buy limit of $25.80 for example. This says, buy my 1,000 shares, but only pay up to $25.80. If there are 1,000 shares between $25.75 and $25.80, your order will fill. If not, whatever amount is left remaining will be posted as a bid at $25.80. I almost always opt to do this instead of using market orders.
Stop Order Buy or Sell (Market or Limit)
A stop buy order is used to buy above the current price. It will buy at the stop order price or higher.
A stop sell order is used to sell below the current price. It will sell at the stop order price or lower.
Stop loss orders are stop orders. For example, a trader buys a stock at $25 and sets a stop sell order at $24. If the stock drops to $24, or below, the stop order is executed and will sell at any price it can get at or below $24. THAT’S ASSUMING IT IS A STOP SELL MARKET ORDER. It is recommended that all stop loss orders are stop market orders, since it is important to get out if the price drops below your exit level.
Stop orders by default are typically market orders.
It is also possible to set stop limit orders. The limit order attached to the stop order caps the price paid or sold at. For example, assume a stock has a big resistance area at $50, and a trader wants to buy if the stock moves above $50, say to $50.10. They could set a stop buy limit order at $50.10 (stop), with a cap of $50.25 (limit). This means buy if the price hits $50.10 or above, but don’t pay more than $50.25.
For the stop loss example, the trader could set a sell stop limit at $24 (stop) with a limit or $23.75 (limit). That means sell if the price drops below $24, but don’t sell below $23.75. While such an order is not recommended as a stop loss, it could be useful for entering a short position. For example, if the trader wants to enter a short position if the price drops to a certain level (such as below support), but wants to limit the price they sell at.
How long an order stays “open” is up to you. You can set an order to expire that day, it can be good-till-canceled, or you can set a day when the order will expire. Day traders will use day orders. Most other traders will use good-till-canceled orders, if available. If you want your orders to expire on a certain day or within a certain amount of time, then set an expiry date.
Setting an expiry is useful if you want the order to last a certain amount of time, but not more. For example, you may expect a trade to materialize shortly, and so you set the expiry for one week. If the order doesn’t fill in that time you want it to be canceled so you can reassess the situation. Good-till-cancelled is ideal if you want to get filled, even if it takes a few months.
Regardless of the expiry set, you can cancel any of these orders at any time.
By Cory Mitchell, CMT