Order types explained: different types and when to use them

Navigating the world of stock and forex markets can feel overwhelming. Even when you're ready to make a trade, which type of order should you use?

To improve your trading strategy and get the best results, it's important to understand the different order types you have available. This guide will explain common order types clearly, outlining their pros, cons, and examples to help you make smart trading decisions.

 

Contents

1. Market Order
2. Limit Order
3. Stop Order
4. Stop Limit Order
5. Trailing Stop Order
6. Good-Til-Cancelled (GTC) Order
7. One-Cancels-the-Other (OCO) Order

 

Market Order

A market order is the most straightforward type of order. It instructs your broker to buy or sell a security immediately at the current market price.

Market orders guarantee execution but not the execution price. This means that if the market is volatile, you may end up paying a different price than expected.

Market orders are ideal for traders who prioritize speed and liquidity over price - you want the order now and aren't as concerned about the exact price.

Pros of Market Orders

• Speed: Execution is swift since the order fills at the next available market price.
• Simplicity: Easy to understand and use, making it ideal for beginners.
• Guaranteed Execution: Your order will be executed provided there is enough volume.

Cons of Market Orders

• Price Uncertainty: The final execution price can differ from the last quoted price, especially in volatile markets.
• Slippage: The difference between the expected price and the executed price can impact returns.

 

Market Order Example

Imagine you want to buy 100 shares of Apple. If the current market price is $50 per share, a market order will purchase the shares at $50, assuming there are enough shares available at that price.

 

Limit Order

A limit order allows you to specify the maximum price at which you are willing to buy or the minimum price at which you are willing to sell a security.

The order will only execute if the market price meets or exceeds your specified limit price. This means that the execution price can be more favourable than a market order, but there is no guarantee of execution.

 

Pros of Limit Orders

• Price Control: You have control over the price at which the order executes.
• Cost Efficiency: Helps avoid overpaying for buys or underselling sells.

Cons of Limit Orders

• No Execution Guarantee: Your order may not execute if the market doesn’t reach your limit price.
• Complexity: Requires more understanding and monitoring compared to market orders.

 

Limit Order Example

Suppose you want to buy 100 shares of Apple but are only willing to pay $45 per share. You place a limit order at $45. The order will only execute if the share price drops to $45 or lower.

 

Market Order vs Limit Order: What's the difference?

As we covered above, the main difference between market and limit orders is the execution price.

With a market order, you receive immediate execution at the current market price, while with a limit order, you specify the maximum purchase or minimum sale price.

Market orders are ideal for traders who prioritize speed and liquidity, while limit orders are better suited for those who want more control over execution prices.

When to use a market order

• Urgent trades: When you need to buy or sell immediately regardless of the price.
• Highly liquid stocks: Market orders work best in highly traded securities that have high trading volume.

When to use a limit order

• Controlling costs: When you're willing to wait for a specific price but don't want to pay more.
• Illiquid securities: Limit orders are ideal for low trading volume stocks as they can help avoid wide spreads and slippage.

 

 

Stop Order

A stop order, also known as a stop-loss order, is designed to limit a trader's loss on a position.

When the price of a security falls to a specified stop price, the stop order becomes a market order and is executed at the next available price.

Stop orders can help minimize potential losses by activating a sell order when a security's price drops below a certain level.

Pros of Stop Orders

• Loss Mitigation: Protects against significant losses by automatically selling off a position.
• Automation: No need to monitor your stocks constantly.

Cons of Stop Orders

• Potential Slippage: The execution price could be worse than the stop price during volatile markets.
• No Control Over Execution Price: Becomes a market order when triggered.

 

Stop Order Example

If you own shares of Apple, currently trading at $50, and want to limit your loss, you set a stop order at $45. If the price drops to $45, the stop order will trigger a market order to sell your shares.

 

Stop Limit Order

A stop limit order combines features of both stop orders and limit orders. Once the stop price is reached, the order becomes a limit order instead of a market order, ensuring that the order will only execute at the specified limit price or better.

This type of order can provide more control over execution prices but may not guarantee execution.

Pros of Stop Limit Orders

• Precision: Allows for precise control of the entry and exit points.
• Reduced Slippage: Ensures the exact execution price or a better one if triggered.

Cons of Stop Limit Orders

• Execution Risk: May not execute if the market doesn't reach your limit price.
• Complexity: Requires more understanding and monitoring compared to market orders or stop orders.

 

Stop Limit Order Example

Taking our previous example, instead of setting a stop order at $45, you could set a stop limit order at $45 with a limit price of $43.

 

Trailing Stop Order

A trailing stop order sets the stop price at a fixed percentage or amount below or above the market price. The stop price adjusts as the market price fluctuates, providing a dynamic risk management tool.

As the market price increases, the stop price rises by the same percentage or amount. If the market price decreases, the stop price remains unchanged.

Pros of Trailing Stop Orders

• Dynamic Risk Management: Helps lock in gains and limit losses as a security's price fluctuates.
• Automation: No need to constantly monitor your positions.

Cons of Trailing Stop Orders

• Price Volatility: The execution price may vary significantly depending on how quickly the security's price changes.
• Potential for Premature Exit: Can trigger an order too soon if there is a temporary dip in the security's price.

 

Trailing Stop Order Example

Suppose you own shares of Google, currently trading at $100. You set a trailing stop order with a 10% trailing percentage. As the price rises to $110, the stop price will also increase by 10%, setting a new stop price of $99.

 

Good-Til-Cancelled (GTC) Order

A GTC order remains active until it is executed or manually cancelled by the trader. This allows traders to place orders without having to monitor them constantly.

These types of orders are often used for long-term investment strategies or when waiting for a specific price to enter or exit a position.

Pros of GTC Orders

• Convenience: Allows traders to set and forget their orders until they are filled.
• Flexibility: Can be used for various trading strategies, including long-term investments and entry/exit points.

Cons of GTC Orders

• Availability Risk: The order may not execute if the market doesn't reach the specified price before expiring.
• Market Changes: Market conditions may change, making the initial order no longer suitable.
• Forgetfulness: Traders may forget they have an active order in the market.

 

GTC Order Example

If you want to buy Google shares at $90 and don't want to keep entering the order daily, place a GTC order at $90. It will remain active until the price reaches $90 or you cancel it.

 

One-Cancels-the-Other (OCO) Order

An OCO order allows traders to place two orders simultaneously. When one order executes, the other one is automatically cancelled. This is useful for managing different market scenarios.

For example, a trader could place an OCO order for a stock at $50 with one limit order to sell at $55 and another stop order to sell at $45. Whichever execution occurs first will automatically cancel the other.

Pros of OCO Orders

• Scenario Management: Allows for planning for different market movements.
• Automation: Reduces the need for constant market monitoring.

Cons of OCO Orders

• Complexity: Requires understanding how to set up and manage two orders concurrently.
• No Guaranteed Execution: Only one of the orders will execute, and the conditions for the second order may never be met.

 

OCO Order Example

If you own Google shares at $100, you can place an OCO order to sell at $105 to take profit, and another to sell at $95 to cut losses. If the price reaches $105, the $95 order is automatically cancelled, and vice versa.

 

Final thoughts

Understanding the various order types available in trading is crucial to optimising your trading strategy and mitigating risks.

Each order type offers unique advantages and potential drawbacks, making it essential to choose the right one based on your trading goals and market conditions.

By mastering these order types, you'll be better equipped to manage your investments effectively and maximise your returns.

Happy trading!