Order Types —The Types of Trades We Make and When To Use Them

By May 8, 2018Trader Tips
Order Types —The Types of Trades We Make and When To Use Them

Let’s put it plainly: you can’t trade without orders. Orders are essential for trading any asset, helped by electronic platforms, of which there is a wide choice these days.

Yet not all orders are created equal. There are five basic types you can choose from, depending on your priorities for the trade (besides making a profit, of course), along with what type of asset you are trading, market trends, and technical indicators.

Here’s an overview of the six most common order types.

#1 Market Order

Market orders are the default option, the base. You pick an asset, a quantity that you want to buy or sell, and place a market order. This means that the moment you click on the Buy or Sell button, your order will be transmitted to the brokerage you are using and executed in a matter of seconds. Market orders also called unrestricted orders for reasons that will become obvious as we move on, have guaranteed execution at the current price of the stock, commodity, bond, or derivative you are trading in.  “Current”, meaning, at the time of execution, not at the time you clicked “buy” on your computer.

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Since it involves almost no work on the part of the brokers, it is usually the cheapest order type – they take it and buy/sell your asset of choice at the current price, that’s it. It doesn’t get much simpler than that.

There are, however, risks involved, related to the inevitability of the order’s execution: if you, for example, want to buy 5,000 shares in a company at the asking price, you will place a market order. But if there are just 3,000 shares put up for sale, you will only get these at the asking price. The other 2,000 may come in cheaper or more expensive, but you can’t change your mind because you’ve committed to 5,000 shares.

 

#2 Limit Order

For those who want to minimize loss from slippage – the widening of the spread between the bid and the asking price for an asset or instrument at your expense – there is the limit order. It’s also a good choice if you want to maximize the chances of a profit within a certain period of time and within a certain price range.

When you place a limit order, you task the brokerage to buy or sell an asset at a minimum price or more, within a certain time frame. This way, you make sure you take a profit, which is why limit orders are also called take-profit orders. However, if the minimum price fails to materialize in the period you have specified, no trade is executed, and you might miss some other good opportunities to profit from the asset.

 

#3 Stop Order

Traders choose the stop order when they don’t have the time to spend the whole day watching their positions or are traveling or engaged otherwise. Stop orders get executed once the price of an asset or instrument goes above a certain level—a stop price— set by the trader. It works by either limiting their potential losses, in which case it is a stop-loss order or by locking in profits that the trader might otherwise miss, as a stop-limit.

 

#3.1 Stop-Loss Order

With stop-loss orders, the priority is not just on taking profit, but also avoiding loss, as the name suggests. It is common with long bets, where you buy an asset or derivative at a certain price, expecting this price to rise, and choose a stop-loss order at a slightly lower price than the one you bought the asset at. If the price of the asset falls to the level you’ve specified, your stop-loss order will be executed, saving you the hassle of watching your position constantly to avoid incurring a loss. One additional benefit of the stop-loss order is that it reduces the scope of potentially wrong decisions based on emotions rather than rationality.

One problem with stop-loss orders, however, is that they are also valid for a certain period, and the order may be executed at a price much lower than the one you specified as a trigger if the price of the asset or derivative falls sharply and suddenly.

 

For example, if you own shares from company X that are trading at $20 and you want to limit potential losses if the stock falls suddenly, you can set up a stop-loss order that will get triggered if the price of the stock falls below, say, $18. The moment the stock falls below $18 your order will become a market order and will be executed. Yet the stock might fall not just to $18 but to $15 and your order will be executed at that level.

 

#3.2 Stop-Limit Order

This is a hybrid between a stop order and a limit order. Traders who opt for it will have to select a stop price and a limit price, and their trade will be executed once the stop price has been reached and when the price has risen to the minimum limit level or over it, automatically becoming a limit order. This gives much more control to the trader than other types of orders, with the drawback that it may remain unfilled if neither the stop price nor the limit prices are reached.

For example, a trader may want to buy some stock in company A that is currently trading at $10, as they believe the stock will rise in the future. They set up a stop-limit order with the stop price at $11 and the limit price at $12. Once the stock reaches $11, the order is triggered and becomes a limit order. If the stock, however, rises above $12, the trade is not executed.

 

#4 Trailing Stop Order

The trailing stop order is a step further than the stop-limit and the stop-loss orders in that it involves the additional factor of a trail amount that is a portion of the price you are willing to pay/receive for the trade. In other words, if you have placed a stop order specifying the minimum price at which it must be executed, to make it a trailing stop order, you add, say, a 10% or a $1 trail, so as the price of the asset moves higher or lower, so does your stop price.

Trailing stop orders can use either a percentage of the price or a fixed amount. They allow you to lock in a higher profit and also to avoid bigger losses than you are prepared to suffer because the trailing works in both directions, for price increases, and for price declines.

 

#4.1 Trailing Stop-Loss Order

If you want to curb your potential losses on a purchased asset or instrument even more efficiently, you can set a trail on the trade the moment you make it. You set up a trailing stop-loss order with a trail of, say, 10%, and as the price of the asset rises—generating profits for you—so does the stop price. If the price of the asset begins to fall, however, the stop price does not follow – it remains at the last level it has reached and when the price of the asset hits it, your sell stop-loss order is triggered.

 

#4.2 Trailing Stop-Limit Order

This type of order is also great if you want to minimize your losses without touching the potential for profits. With it, you have to set up two trail amounts, a stop price, and a limit price and then wait until the limit level is reached—with both the stop trail and the limit trail rising in unison—and the order turns into a limit order once the stop price is hit.

This type of order works just like a stop-limit order with the difference that the stop and the limit prices are not fixed numbers but flexible ones, moving in unison as the asset’s price moves up or down. This allows a selling trader to limit their potential losses even more efficiently – losing 10% of $20, for example, means losing $0.20, rather than $5 in case the asset drops suddenly and sharply. It also allows a buying trader to get a better deal for an asset they want to buy – the order will be executed the moment the limit price is hit. This limit price freezes the moment the asset price starts going up, like the stop price in a sell stop-limit order.

All these types of orders and combinations between them have made a trader’s life much easier than it used to be, as long as you learn how to use them. They are there to take emotions out of the equation and enhance your trading discipline, along with the more obvious advantages of improving the chances of you making a profit and limiting the risk of losses.

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Join the discussion 7 Comments

  • Fernando says:

    Just one comment that should be added to 3.2:

    LONG Stop-Limit Order: Stop MUST be above current price
    SHORT Stop-Limit Order: Stop MUST be below current price

  • Luis Paredes says:

    Very good insight on the difference between these orders…

  • Josue Lugo says:

    Hi Stocks To Trade, I want to say this article was very helpful but I wanted to ask my question as an example because I’m still a little confused… So let’s say if I buy a stock at $5 and I want to control my loss and profits when I leave the computer. $4 is the lowest I’ll will want to lose then sell and $6 I would like to sell and profit. Now do I set two separate orders for loss and profits or does one type of order do 2 in 1? I’m guessing it’s “#3.2 Stop-Limit Order”
    I hope you understand my question, sorry if you don’t, I did my best. Thank you very much.

  • Uia says:

    informative…thank You

  • DIANE DAVID says:

    Wow. Okay. Thanks.

  • Deborah Mason says:

    Been wantin’ to get detailed information regarding order types for a looong time. Very helpful ~ thanks!

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