In the trading context, an order represents a trader’s intent to buy or sell a particular asset at the current… Continue readingCommon Order Types in Trading

In the trading context, an order represents a trader’s intent to buy or sell a particular asset at the current price or a specified price.

What is an Order in Trading?

In the trading context, an order represents a trader’s intent to buy or sell a particular asset at the current price or a specified price. It is an instruction given to a third party (broker, bank, exchange) to execute a trade on behalf of the trader.

Orders can range from basic to complex, created to fulfill varying trading intents. Without orders there are no markets as they are the primary means of communication between a buyer and seller, ensuring that financial exchanges run smoothly. In today’s markets, orders are processed mainly by automated systems, which enables rapid execution and minimization of human errors. 

The financial markets process millions of orders per time and one execution can trigger a series of others which creates a chain reaction of price fluctuations. This interconnected nature of the markets is due to orders.

That said, due to the number of orders and their complexity, brokers, and exchanges are mandated to ensure the reliability of their order-clearing systems to prevent price disruptions.

Understanding the different order types and how they affect the market is vital to effectively navigating the markets.

 Top 6 Order Types

 Market Order

A market order is a request from a trader to a broker to buy or sell an asset immediately at the best available price. A market order is used when the goal is to execute a trade immediately.

While it ensures the execution of the trade, it doesn’t guarantee a specific price. A market order is executed immediately at the current market price, regardless of whether the price is favorable or unfavorable for the trader.

A market order is suitable for traders who are not concerned about the exact price they execute their trades. It is also useful if you need to execute a trade quickly to avoid a significant price movement. This order type is suitable for day traders who want to take advantage of short-term price movements.

Also, when placing market orders, the market needs to have a certain level of liquidity. If there is not enough liquidity, the request may not be executed or may be filled at a price far from the current price.

Market orders are best for assets with high liquidity and trading volume. Assets with high volume and liquidity often have narrow bid-ask spreads, which reduces the price slippage for market orders. This order type is not suitable for assets with low liquidity or trading volume because they are susceptible to significant price slippage, which can result in the trader paying more than the market cost to execute the trade.

Aside from the fast execution of trades, another benefit of market orders is the absence of price restrictions. This means that there are no price limits on trades. Trades can be executed at the best available price. This is often useful in volatile market conditions.

Advantages	Disadvantages
Fast execution	No price control, possible slippage
Suitable for day traders	Risk in low-liquidity assets

 Limit Order

This trading order instructs a broker to buy or sell an asset at a specific price. The limit order restricts the maximum price to buy (buy limit order) or the minimum price to be received (sell limit order).

With a limit order, the trade only becomes active when the price reaches the specified limit price. If the market price does not reach the set price, the trade will not be executed until it expires.

Aside from being a trading order type, limit orders also serve as a risk management strategy. Limit Orders are suitable for traders who are price-sensitive and want to have more control over their transactions. The ability to specify the exact price to execute a trade provides some degree of control in volatile financial markets.

Day traders who wish to take advantage of small price movements may not find this order type appealing as it can result in delayed execution or unfulfilled orders. Limit orders help traders to avoid overpaying or underselling. With this order type, traders can set a price floor or ceiling if they are bothered about paying too much or selling for too little.

That said, limit orders are not suitable for highly volatile markets. In highly volatile markets, the prices of assets fluctuate so fast that it becomes difficult to predict whether a limit order will be executed. It is also not suitable for time-sensitive trades as limit orders are not executed immediately, and it may be hard to tell if the market price will get to the set price.

Advantages	Disadvantages
Control over execution price	May not execute if price is not reached
Useful for volatile assets	Unsuitable for quick market moves

 Stop Order

A stop order is a trading order to buy or sell an asset at the market price when the asset has traded at or hit a specific price.

In most cases, selecting a price worse than the current price is known as a stop order. With stop orders, traders often buy worse (at a higher price) or sell at a lower price.

Types of Stop Orders:

• Buy Stop Order: A buy stop order is used when you want to buy an asset at a price above the current market price. It’s often used by traders expecting a breakout. Once the asset hits the stop price, the order converts to a market order and gets executed at the next available price.
• Sell Stop Order: A sell stop order is the opposite of a buy stop. It’s used to sell an asset if its price drops to or below a certain level.
• Stop Loss Order: A stop loss order is designed to limit the potential loss on a trade. Traders use it to exit a position automatically if the market moves unfavorably. For instance, if you buy a stock at $100 and don’t want to risk losing more than $10 per share, you can set a stop loss order at $90. If the stock price drops to $90, the stop loss order will sell your shares, helping to cap your losses. It’s a key risk management tool that helps protect your capital.

Since this order type is automated, traders can easily protect their position against market volatility without actively monitoring the market. Stop orders are not suitable for traders who want to time the market. It is also not recommended for traders concerned about the risk of slippage, which can occur when a stop order is executed.

Type	Description
Buy Stop Order	Buys when the price hits a level above the current market price, used for expected upward breakouts.
Sell Stop Order	Sells when the price falls below a certain level, ideal for minimizing potential losses.
Stop Loss Order	Sells to limit potential losses, protecting traders from significant downturns.

 Stop-Limit Order

A stop limit order is a conditional trade order that combines the functions of a stop and limit order. With a stop-limit order, you need to place 2 prices – the stop price and the limit price. If the asset hits the preset stop price then your order becomes a limit order.

Stop-limit orders, unlike stop orders, ensure a price boundary based on your preset limit price. Stop orders, on the other hand, guarantee order execution but not necessarily at the exact specified price.

For instance, if Microsoft is trading at $155 and you want to buy the share once it begins to have upward movements, then you’ll place a stop-limit order to buy at a stop price of $160, and a limit price of $165.

You can buy or sell with a stop-limit order. Buy stop-limit orders are set above the market price, but sell stop-limit orders are placed under the current market price.

 Trailing Stop Order

A trailing stop order is a type of stop-loss that follows your position. If the price of the asset rises, it secures your position. However, if the asset or stock price falls, it remains in place and closes your position.

Unlike a regular stop loss, a trailing stop order does not place the stop level at a specified price but rather at a preset distance from the current price.

 Good ‘Til Canceled (GTC) Orders

A Good ‘til canceled (GTC) order remains active till the order is executed (filled) or canceled. Brokerages typically limit the maximum time that a GTC order can be open to approximately 90 days, depending on the broker.

 What Is an Order Execution?

An order execution is the process of completing a buy or sell order. Order execution happens when the order is filled, not when it is placed or requested. The process is usually automated.

 Conclusion

Orders are the backbone of trading as they facilitate the buying or selling of assets in the financial markets. From the basic market order to more complex stop/limit orders, these tools are essential for traders. Understanding these order types is crucial if you want to become a professional trader.

 FAQ

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Leverage is the use of borrowed funds from a broker to amplify your trading position beyond your own capital. For instance, leverage can allow you to multiply your position by 10x, 20x, or even 100x, enhancing your market exposure.

Regular trading involves using only your deposited funds to speculate on price movements, while leverage trading means most of the capital is provided by the broker. You only need to place a margin deposit, which is typically a fraction of the full position value.

Example: Opening a forex position worth $2,000 may only require a $100 deposit with a 20x leverage ratio, where your broker provides the remaining $1,900.

How Does Leverage Trading Work?

Leverage trading works by requiring the trader to put down a deposit known as a margin, which makes them eligible for increased exposure on a trade. Simply put, with leverage you only need to put a fraction of your position’s value to open a trade but your return or losses are calculated based onthe trade’s full value, not the margin.

For example, if you intend to buy 1000 shares of Tesla at the price of 100 cents on a regular trade account, your broker would require you to pay 1000 x 100 cents for exposure of $1000 minus commission and other fees. But with leverage, you can pay a fraction of this cost upfront. So, if the margin trading amount was 20%, you’d pay $200 to open the position. However, your returns and losses would be calculated on the full $1000.

If, for example, you opened a long trade and Tesla’s stock price rises by 40 cents, your 1000 shares are now worth 140 cents each. When you exit the position, the outcome would be that you doubled your margin amount of $200 and received $400.

If Tesla’s stock price fell by 40 cents, you will make a $400 loss, still double your initial margin. In essence, the losses or returns are greater than your margin amount in this example.

Example:

• Position Size: $1,000 for 1,000 shares at $1 each
• Margin Requirement: 20% or $200 deposit
• Profit/Loss Calculation: If share prices rise by $0.40, the profit would be $400, doubling the initial margin.

However, losses can also double, demonstrating the risks of leverage.

What is Ratio in Leveraged Trading?

Ratio or leverage ratio is a measurement of your trade’s total exposure compared to its margin requirement. The ratio amplifies your trading power and shows how much your trade size is magnified as a result of the margin held by the broker.

It indicates the relationship between the trading capital and the total value of the position you are controlling.

Ratio in leverage trading is expressed as a fraction, for example, 1:100. The numerator represents the money being invested while the denominator represents the total value of the position you control.

This means that for every $1 you invest, you would control a position worth $100.

The higher the ratio, the higher the position size you control.

Higher ratios mean larger positions, but also increased risk.

What Financial Products and Markets Allow Leverage Trading?

Leverage trading is not available for all markets and assets. The availability of leverage may depend on the underlying asset or specific market. This is because several factors such as market liquidity, brokerage policies, regulatory restrictions, and asset types can affect its availability.

Leveraged trading is more common in markets or assets with high liquidity because this ensures that there are a lot of traders to facilitate transactions. There are low chances for leverage trading including on markets/assets that are characterized by extreme volatility, low levels of liquidity, and major fundamental risks.

However, several financial markets support leverage trading as listed below:

Forex Market

The forex market is one of the most popular markets for leveraged trading as it offers a wide range of currency pairs and high liquidity.

The forex market allows high leverage ratios like 1:500 or more. This makes it perfect for experienced traders who can take advantage of market movements but are able to appropriately manage risks.

Futures Market

Futures contracts are agreements to trade a specific asset at a predetermined price on a future date.

With the futures market, leverages are built into the contract itself, this enables traders to control larger positions than their initial investment.

In most cases, the leverage ratio for futures contracts is determined by the platform.

Also, traders are often required to deposit a percentage of the contract value (margin) as a security deposit. 

If the trader’s account balance falls below the required maintenance margin, they will receive a margin call, informing them to deposit additional funds to maintain their position.

Failure to meet a margin call can result in the liquidation of the position.

Options Market

Assets on the Options market have embedded leverage. This means that if you do not borrow funds from your broker to trade Options you would still have levered exposure to the underlying asset.

For instance, say it costs $2349 to buy an ounce of gold. With Options, you can use $32, which is only 1.37% of the amount to buy an October call option on an ounce of gold.

So if gold rises to $2500 by October, a long position with gold gives you ($2500 – $2340) / $2340 = 7% in gains. But with a call Option, you get ($2500 – $2340 – $32) / 32 which is a 400% return.

However, if the price of gold does not rise by October you’ll get a 0% return holding gold but a -100% return on your call option position. So like any leveraged position, the call option amplifies your gains and losses. 

Margin Accounts

Margin Accounts are brokerage accounts that allow traders to borrow funds from the broker to purchase securities. The borrowed funds often provide leverage which enables traders to control larger positions.

In most cases, the leverage ratio in margin accounts is determined by the broker and can vary depending on the type of securities being traded.

Market	Description
Forex Market	Popular for high leverage ratios (1:500+), suitable for experienced traders who manage risk.
Futures Market	Contracts include leverage, often requiring margins to maintain positions.
Options Market	Embedded leverage provides exposure without direct borrowing from brokers.
Margin Accounts	Brokerage accounts allowing borrowed funds to control larger trades, ratio varies by broker.

Pros and Risks of Trading with Leverage

Pros

Leverage trading offers traders several benefits especially if the trader is experienced and has proper risk management strategies. Below are some advantages of leverage trading:

• Increased Buying Power: Leverage trading increases the traders’ buying power and enables them to trade more assets than they could with their own funds alone.

This increased buying power enables traders to open bigger positions.

• Hedging Strategies: Leverage can also be used to hedge or protect existing positions against potential losses. While this is complex, it comes in handy when you want to minimize the risks of an open position.

Benefit	Explanation
Increased Buying Power	Open larger positions than possible with your own funds alone.
Hedging Strategies	Use leverage to protect open positions against adverse price movements.

Cons

Leverage trading is risky and is not recommended for inexperienced traders.

• Amplified Risk of Trading Capital Loss: The risk of losing your trading capital is high with leverage trading. An adverse price movement can devastate your trading capital especially if you don’t have risk management measures in place.
• Margin Calls: Margin calls are often made when your account balance falls below a certain level due to loss. Margin calls require you to deposit additional funds to maintain your position. Failure to do so often results in the liquidation of your position. This is often done at an unfavorable price.
• Stress: Leverage trading can be emotionally draining and stressful due to increased exposure to loss. Stress in trading is often catastrophic as it results in impulsive decisions that can jeopardize your trading position.

Risk	Explanation
Amplified Risk	Losses can exceed your initial margin, making leveraged trading risky for inexperienced traders.
Margin Calls	Brokers may require additional funds if your balance drops below a threshold, risking position liquidation.
Emotional & Mental Stress	Increased exposure can lead to stress, resulting in impulsive, risky decisions.

How to Manage Risk in Leverage Trading

Forex trading with leverage is risky as losses can exceed your margin, but you can use risk management tools like Stop Loss orders, Guaranteed Stops, and Negative Balance Protection to reduce potential loss.

With Stop Loss if the price of the underlying asset moves against you, the trade will be closed at the price you’ve set. Guaranteed Stops work the same as Stop Loss but ensure that the exit point does not exceed the price you set, irrespective of volatility.

Negative balance protection means that if your balance goes to negative, the broker will push it back to zero without charging you.

Effective risk management is crucial when trading with leverage. Here are some recommended tools:

Tool	Description
Stop Loss Orders	Automatically close positions to limit losses if the market moves against you.
Guaranteed Stops	Ensure trades close at the set price despite market volatility, avoiding slippage.
Negative Balance Protection	Prevents your account from going below zero, resetting it without extra charges.

Conclusion

Leverage in trading allows you to increase your position size which reduces the initial investment required. However, it amplifies potential losses or returns as you can lose your entire initial capital. So, it is important to include risk management tools like stop loss in your trading strategy when using leverage. Plus, go for a broker that offers Negative Balance Protection.

FAQ

Tip: Always apply careful risk management strategies to avoid substantial losses when trading with leverage.

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