I was surprised when a recent comment asked : what is a limit order in trading? This was from someone who suggested they were ready to go live with their trading account.
There are a few ways a trader can enter a position when their preferred trading setup show up. The one you use can actually make a difference in the outcome of a trade.
Each one serves different needs so let’s cover what I would call “Trading 101”.
This is the most basic trade entry you will ever make.
When your buy or sell signal shows up, you can enter the market “at the market” which means the price that is available.
You would use this if you needed to get into a trade or out of a trade quickly.
The issue with there are that the bid/ask price is constantly fluctuating. If you see a price of 1.3400 for example and you want to enter a buy by pressing “Buy”, by the time the order occurs, price may have gone down or up. If price goes up, you bought more expensive and with down, you got a cheaper price.
If you trade Forex and have ever traded the FOMC release, you have seen that using market orders can get you into the trade at a worse price than you planned. This will increase your risk and will skew your position sizing model
What are Limit Orders?
I personally prefer these types of orders. These orders are only filled when price reaches the price you have chosen to enter the market. My broker actually uses the word “limit” to describe something that actually has two names which depend on whether you are buying or selling.
Buy Limit Order
Once you set these in your broker platform, you have set instructions to buy if the market reaches your price or lower. Limit buys are always set BELOW the current market price.
You would also use a buy limit order to take profits when you are short an instrument.
Sell Limit Order:
The exact opposite of buy limit. Your order to enter the market short is set ABOVE current price.
The positive of setting a limit order is that you will get filled at the price you choose. The negative is price may almost reach your entry price and then turn leaving you on the sidelines without a fill.
If you are in a long trading position, you would use a sell limit as a means to take profits.
Buy and Sell Stop Limit
These are orders that do not convert to market orders when hit. They will prevent you from buying or selling at a worse price than you intended.
As an example, in a rising market, instead of using a buy stop that can get slippage, the buy stop limit will prevent a higher price order but can get me filled at a lower than expected price.
These are an interesting type of order and they do have a unique quality about them and that is they combine the attributes of both limit and market orders. For brevity sake, these orders are the opposite of the limit orders.
- If you choose to enter a market long, setting a buy stop order has you setting an order ABOVE the current price.
- Sell stops have the order set below current price.
The main drawback when you choose to use a stop order to enter the market is the same drawback you get with market orders and that is…filled at the best possible price.
This means you can suffer from slippage, and when designing or testing a system, keep it in mind as slippage can have a direct impact on the profitability of your trading system.
One of the most important orders you should know and use is a stop-loss order. When in a trade, these are the orders that can get you out if the trade is not doing very well.
It can also get you out of profitable trades if you “trail” the stop behind price to lock in profit.
Many traders love the set and forget ability of setting a stop-loss order. You are essentially safe in knowing that the risk you can tolerate is protected by a stop order and you don’t have to remain glued to the trading screen. Ensure you set one the moment you enter a trade.
It can be confusing when learning about the different orders that a trader can use. The trick is to ensure you know them well enough that you don’t choose the wrong one when entering a trade.
When learning a new order entry system or overall trading platform, ensure you have gotten used to placing the different types of orders depending on your trading plan.