Brokers offer many different types of orders that allow you to enter, exit and also program your trades. The different types of orders help in supporting all kind of trading styles. The most common order types offered by brokers are: market orders, limit orders and stop loss orders. This post will discuss the most common order types.
Most common order type is the market order. A market order is executed immediately when placed. This is done against the current spot, or market price. For example, you want to enter a long EUR/USD position and the current bid/ask spread is 1.1180|1.1182, you will buy at ask price 1.1182.
A market order is the default option and is likely to be executed since it does not contain restrictions on price or timeframe in which the order is executed. Therefore, a market order is also referred to as an “unrestricted order.” Since these market orders are rather simply for brokers due to the lack of restrictions, the commission fees are often low on them. Keep in mind that when traded volume is low, the bid/ask spread can be rather large. In other words, you are likely to end up paying a lot more than anticipated. Therefore, be a bit wary in such circumstances when using market orders to enter or exit a position.
When you close a trade position manually, it is also technically closed by executing a market order of the same amount of your current position, but in opposite direction. So a one lot long trade EUR/USD can be closed manually by going short 1 lot EUR/USD. This is also referred to as an offsetting or liquidating transaction.
Entry stop order
Another type of order is the entry stop order. You can pre-set this order into the platform to buy or sell at a specified price. For example, you want to take a long position EUR/USD once it hits a certain price, let’s say 1.1200. An important detail is that the entry stop price on a buy order must be above current ask price, and on a sell order it must be below current bid price. Be wary that not all broker-dealers guarantee execution at or near the stop price.
In some occasions it’s possible to add a second variable to these entry stop orders: a time duration. So besides that you validate at which price you wish to buy or sell, you can also specify the time that your order will remain valid.
In the very rare occasion that the broker can’t find a match for your entry order the dealer will act as a market maker and take the other side of the trade. But usually the broker-dealers have no problem matching your position.
Unlike the market order, the limit order is an order to buy or sell a currency pair only when certain conditions are met. These certain conditions can be included in the original trade instructions. So until these conditions are met, the order is a so-called ‘pending’ order, meaning it doesn’t affect your account totals and margin calculation. Often pending orders are used to create an order that automatically executes when the exchange rate hit a pre-set target level.
An example for a trend trader would be that you expect that the pullback is over and the market is ready to begin the new upswing. You want in that case place your limit buy order at a price slightly above the market rate. If the market indeed turns and is starting to move upwards it will hit your limit order and your position will be opened. If your prediction is wrong the order will not be executed.
As said in the example above, the execution of a limit order is not guaranteed, but it ensures the trader he is not paying more than he is willing to. Limit orders also allow an investor to add a time constrain that an order is outstanding before being canceled. Depending on the direction of the trade taken, limit orders are often referred to as a buy limit order or a sell limit order.
Since limit orders are more difficult to fill, they typically cost more than market orders. On the contrary do limit orders let investors get their specified buy or sell price. Where we discussed earlier the risks of using market orders in low volume and highly volatile market environments, this is where limit orders are especially useful.
Stop Loss Order
A stop loss order is a pre-set limit order which automatically closes an open position when the exchange rate moves against you and hits a specified price. A stop-loss order protects against further losses, including avoiding margin closeouts. Since it is a protection for losses these stop loss orders are placed below the spread in case of a long position, and in a short position above the spread. A stop loss order remains active until cancelled or the position is liquidated.
For example, if you take a long position USD/JPY at 121.60, you could set a stop-loss at 118.80 – having the effect that, if the bid price falls and hits this level, the trade is automatically closed, thereby capping your losses. It is important to realize that stop-loss orders can restrict your losses, but they can’t prevent them.
Like limit orders, stop losses are useful if you don’t want to monitor price action all day. They also prevent you from losses due to technical errors as power shutdowns, computer crashes, events occurring while you sleep or just a failing internet connection.
It is highly recommended that you always include stop-loss orders for your open positions. Think of them as a basic form of insurance.