Order Types

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Order Types

Order types define the conditions and prices at which buy or sell trades are to be executed. While trades with various order types have historically been handled by the broker, many traders now use their own software to follow the markets and handle various order types on their own.

One of the benefits of using specific order types directly at the brokerage firm is that a requested price can be guaranteed. For example, suppose a Limit Order for a long trade is requested at 25.75. If the Limit Order is executed by the broker, a price of 25.75 or better is guaranteed.

However, if the trader's own software package triggers a Market Order when the price has dropped to 25.75, there is a chance the price might rise again before the order can be executed. In other words, the Limit Order price cannot be guaranteed if the software package ultimately processes the trade as a Market Order. A quality software package will execute the trades with the broker using the same order types defined in the trading system. However, many brokerage firms offer a limited number of order types.

Depending on the complexity of the order types being used, some trades may be executed more quickly than others. For example, most brokers will execute Marker Orders first, and then proceed with other order types. A brokerage firm may prioritize the order types in other ways as well. For example, Limit Orders may be processed more quickly than Stop Limit Orders. If timing is important, traders should check with their brokers to identify the sequence in which the different order types will be executed.

Even if the price travels into execution range using certain order types, there is a chance that the trade may still not execute. For example, suppose there is a Limit Order of 25.75 to enter a long position. The trade price may drop to 25.50 or lower before heading back above 25.75, and the trade still will not have executed. In most cases, the reason is that Limit Order from other traders had been placed in the queue, and therefore had a higher priority. But it is also possible that other traders began placing Market Orders when the price dropped below 25.75. As is the case with most brokers, Market Orders are executed first, leaving Limit Orders with less chance of getting filled in that small span of time in which the price dropped below 25.75.

There are many software packages that allow back-testing of different order types. StrataSearch, in particular, contains a number of order types features that allow traders to test Market, Stop, Limit, and Trailing Stop Orders using variables. Using variables, traders can optimize their entry and exit prices, identifying prices and conditions in which they can obtain a better price or lock in a profit.

The following are some of the more common order types:

Market Order
A Market Order is the simplest of the order types. The trader enters a request to buy or sell a security and the broker executes the trade at the best price available. While a Market Order typically receives the fastest execution, there are risks with not having a required price. For example, for a stock with little liquidity, a seller may have placed a Limit Order significantly out of the current price range. If a Market Order for a buy is placed, and there are no sellers besides that limit order, the buyer may enter that trade with a very poor price. Most experienced traders place Market Orders only with stocks or other securities that have very high liquidity.

Limit Order
A Limit Order is also one of the more common order types. It ensures that a trade is executed at a specified price or better. For example, suppose XYZ is currently trading at 65.00 and a Limit Order is placed at 63.50. If the price travels down to 63.50 or lower, the Limit Order will be executed. Traders may use Limit Orders for multiple reasons. In some cases, a trader may want to get a better price prior to executing their trade. But in other cases, a trader may simply wish to add assurance that their trade will not be executed with a bad price. For example, if XYZ is trading at 65, the trader may enter a Limit Order of 66. While the trade will be filled immediately in most cases, the trader also has assurance that poor liquidity will not execute their trade at 70 or even higher.

Stop Order
The Stop Order is another of the more common order types. While typically used to minimize potential losses of an existing position, a Stop Order can also be used to enter a position after it has traveled a certain distance in a favorable direction. Entering a Stop Order with the broker may be the best way to protect positions in the event of a catastrophic event. For example, if the market should unexpectedly begin to drop, a standing Stop Order will automatically exit the position and protect the trader. Likewise, if the trader suffers from an internet connection failure or other technical glitch, the Stop Order will protect the trader from excessive losses. Many experienced traders maintain good-till-canceled Stop Orders on their positions to protect against such situations.

Stop Limit Order
One of the slightly less common order types, the Stop Limit Order is processed as a Stop Order followed by a Limit Order. When entering a position, the initial Stop Order for a long trade is not processed until the price has moved up above the specified stop price. When the stop price has been hit, the Limit Order at the same price is then triggered, executing the trade only if the limit price or better can be received. For example, suppose XYZ is trading at 25 and a Stop Limit Order is placed at 27. If the price travels above 27, the order will then be executed if a price of 27 or better can be obtained.

Trailing Stop
A Trailing Stop is also one of the common order types. Similar to a Stop Order and available only when exiting positions, a Trailing Stop will exit a position when it has moved a certain percentage in an adverse direction from the best price seen up to that point. For example suppose a 10% Trailing Stop is placed on a position that was entered at 7. While the position was held, the price then rose to 10 before dropping back down. Since 10 is the best price seen up to that point, the Stop Order will be place at 9 (10% below the high price of 10). Trailing Stops are useful order types when traders wish to lock in profit while still allowing the price to rise.

Market if Touched
The Market If Touched is one of the less common order types, but is still available with many brokers. In short, this order type operates as a Stop Order, but does not provide a guaranteed price. Instead, once the specified price has been hit, the trade is executed as a Market Order. For example, suppose XYZ is trading at 25 and a Market If Touched order is placed at 27. If the price travels to 27, a Market Order will be executed to buy XYZ at the best price available.

Limit if Touched
Also one of the less common order types, the Limit If Touched order type is similar to a Stop Limit order, but requires the price to move in a favorable direction prior to execution. For example, suppose XYZ is trading at 25, and a Limit If Touched is placed at 23. If the price moves down to 23, the Limit Order will be triggered and executed on if a buy price of 23 or better can be obtained.

Market On Close
This particular order type allows traders to exit positions at the day's close price, or as closely to the close price as possible. Many traders do not wish to hold their positions overnight, so a Market On Close order type is entered to ensure positions are exited at the end of the trading day.

Limit On Close
Similar to a Market On Close order type, the Limit On Close will execute the position at the close price, but only if a favorable price can be obtained. There is no guarantee that a Limit On Close will be executed, but it allows trader to execute a trade at or near the market close, if the trade can be filled at a good price.

While the choice of order types is often limited by the broker, or the software package being used to trigger entries and exits, traders should make their choice of order types carefully. A poor choice of order types can result in trades being made at extremely poor prices. Using the most effective order types for the trading system or method being used can greatly enhance the overall performance.