For the novice trader, placing orders can be a source of confusion and frustration. It can lead to errors that should be avoided and can affect a traders underlying PnL. Even for the more experienced trader, placing the correct order for a desired outcome can be confusing. In order to understand which may be the best order to use for an entry (or exit), we firstly need to understand what we are trying to achieve. By knowing what we are looking for with a particular entry style (ie breakout entry, pullback entry etc), then we will be able to use the type of order that best suits and avoid any unwanted mistakes.
The first thing that we need to know is the basic types of orders that are available for online trading platforms and the mechanics of how they execute. While there are many complicated orders, the main ones to understand are :- Limit, Stop, Stop limit and Market. Generally speaking, most online trading platforms will offer these order types for traders and they enable us to achieve any outcome we want as long as we understand them. Most people can grasp the order concept when talking about ‘buying’ but find it difficult to understand when ‘selling’ or ‘shorting’ a share. For any transaction there is a buyer and a seller. If we think of someone wanting to buy a share, they do not want to pay too much and therefore place a ‘limit’ on how much they are willing to pay. For the other side of the transaction the seller, they want as high a price as they can get so will have a lower ‘limit’ on what they will accept; anything less and they will not sell. This is the basic ‘Limit’ order whether buy or sell.
A stop order is generally used to protect a position but can also be used to enter a share ie/ buy on a break above $10 for XYZ share. If we buy into a share price then we want to minimise the loss with a sell ‘on stop’. IF we buy at $10 for example, then we may place a ‘sell stop’ at $9 and it will only activate if the share price drops and trades at $9. For a short sell at $10, then a ‘buy stop’ may be placed at $11 to limit potential losses (it is the reverse of a buy). For a ‘stop limit’ order, it is similar to a ‘stop’ but only really used to enter a share. Again, if we want to buy XYZ at $10 (the share is trading below $10) and we do not want to pay above $10.05, then we use a ‘stop limit’. This is better than a stop order to enter in a fast or thinly traded market when slippage may occur. Again the opposite for short selling. A market order is when we just want to enter or exit a share at the next best price. Again, if we are up on XYZ from $10 and it is struggling around $11.90/11.95 and we want to exit quickly, we can simply sell at market. This means that we accept the next best price (or average price depending on the volume we are selling). If our target price was $12 then the share has to trade at or above $12 to exit with a limit order and we run the risk of a large pullback in price.
By understanding the mechanics of how each of these order types work for both buying and selling, then we will be able to trade successfully with out unwanted execution errors.