Order Types in Trading: Why Choosing the Right One Matters

Ted saw his $1,200 investment turn into $1,500 within hours. Upward momentum was strong, so he chose to hold the position and decided to exit when the price touched $1,600; 33% gains would be great, he thought. He went out for lunch, and a news update turned the market sentiment around.

His investment value? 

Down to $1,335!

Disappointment at its peak.

If only he had placed a limit order, he could have locked in the gains he saw just a while ago. Incidents like this are common in the trading world. The markets are inherently volatile and react rapidly to major developments. That’s why using the appropriate market order type is important. More than a preference, these help you lock in profits and minimise losses. They can also prevent you from missing out on opportunities. Understanding and using the common order types is a way to manage risk and have greater control over your positions.

Types of Trading Orders

There are basically 3 types of trading orders:

• Market Order: Seize the Moment

Market orders focus on speed. A market order is essentially an instruction to buy/sell a specified number of units of an asset right away, at the current price.

When to Use

• Speed matters more than gains to you.
• You are trading an asset with tight spreads and high liquidity, i.e., slippage will potentially be low.
• The price point at which the order is filled holds little to no significance in your trading plan.

Avoid market orders during highly volatile periods, since slippage could derail your trading strategy. Also, pay attention to your trading platform or network’s latency. Delays may result in costlier purchases or cheaper sales than you expected. Using a VPN is a good option to reduce trading latency.

• Limit Orders: Your Price Point Above Everything Else

A limit order is an instruction to execute a trade at your specified price point.

For instance, one lot is priced at $1,500 at present, but you’d like to buy it at $1,450. You speculate on a pullback and place a limit order accordingly. Now, if the price pulls back to $1,452 and then goes up, your order will not be filled, although you were almost there. You can also cancel the order at this point. If you leave it as is, it will be cancelled automatically when it expires.

While the technique offers greater control, it may result in missed opportunities. These orders are executed at the given price point or left to expire. Placing limits realistically, based on careful technical analysis, is therefore important. 

Limits can be placed on sell orders as well. For instance, you find an asset on a downturn and want to let it go from your portfolio. However, a price of $150 seems a bit stretched, so you place a sell order at $155, waiting for a momentary spike to help you save some of your gains. When the price hits $155, the order will be executed at your sell-limit.

When to Use

• You want to lock in profits for an asset that is trending up, before the market reverses.
• You are trading an illiquid asset and can wait till it reaches your preferred price.
• You are trading highly volatile assets and want to have control over entry and exit without missing the opportunity.

Do not ignore the market hours and conditions while placing orders. Orders may behave unpredictably during opening or closing hours of the market. Your order may be executed even if you did not want it to, or you may have to hold positions overnight.

• Stop Orders: Trigger-Based Actions

Stop orders are an improvement over limit orders. Instead of specifying the exact price point, you specify a trigger point. For instance, if the price breaches the resistance or support level. Buy stop orders are executed if the price falls below your specified level and sell stop orders are executed when the price rises above a specified level.

Consider an asset trading at $250 per unit. You can place a sell stop order at $225, and it will be executed only when the price falls below that level.

When to Use

• You find an overvalued asset and want to buy it during a price pullback.
• You find an undervalued asset and want to sell it, but the price spikes.
• You hold a position in a volatile asset and want to automate protection in case the market moves unfavourably.
• You want to confirm a trend before riding it.
• When trading breakouts or as a risk management technique.

Your broker may allow you to extend your order to after hours, which is a specified time after the market closes for the day. Make sure you consider these and the corresponding market behaviour during those hours, while using the facility. Choose the order type appropriately to strengthen your trading plan.

To Sum Up

• Different order types help traders exercise greater control over their trading positions.
• Market orders focus on speed and are filled immediately.
• Limit orders focus on controlled entry and exit.
• Stop orders offer a little flexibility to your trading plan.
• These order types can help improve the execution of your trading strategy.
• Knowing when to use which order type is crucial to making the most of each of them.

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