| The Market Order | The Limit Order | The Stop Order |
Common Types of Orders
A futures or options order originates with the customer, and is simply a set of instructions for the executing broker. A trader uses a futures order or options order to tell his broker exactly what to buy or sell, when to do it, and at what price. There are many types of orders, each being used during different occasions, but the most common are the market order, the limit order, and the stop order. The examples below use these orders for futures transactions, but the identical orders can be used for option transactions. All orders are assumed to be day orders, meaning that they automatically expire at the end of the trading day if not filled or executed, unlessit is specified that the order is "open" or GTC (Good Till Cancelled). A GTC order remains a working order session after session until it is filled or cancelled by the trader who put in the order.
A market order is the simplest of orders and is used when the greatest priority of the customer is for immediate execution. An order is executed or filled when the futures contracts have all been bought or sold, depending upon the instructions in the order. A market order instructs the executing broker to buy or sell futures contracts immediately at the market price, the best possible price for immediate execution. Market orders are the easiest way to enter or exit a market since the customer receives immediate execution - and must pay or receive whatever price is necessary for immediate execution. For example, a customer who wants to sell 5 March cotton futures immediately would call his broker with a market order to sell 5 March cotton at the market.
There are times when a market order may not result in immediate execution.
Some futures contract markets have price limits
outside of which no trades can be executed. If prices rise and reach the
upper limit, one may be unable to get execution of a market order to buy
since sellers may be waiting for prices to go even higher. Similarly, if
prices fall to the lower price limit, one may be unable to get execution
of a market order to sell since buyers may be waiting for prices to fall
even further. In these cases, the trader must wait until the price limits
are expanded, which may not happen until the next day, before a market
order can be executed. For example, cotton futures may have price limits
set at three cents per pound above and below the previous day's settlement
price. If prices rally to the upper limit, a market order to buy may go
unexecuted and returned as "unable". The market order will have to be re-entered
the following day when price limits are expanded. As well, a market order
may not result in immediate execution during times when trading is very
thin or illiquid. In these cases, there is no available counterparty to
your trade and your market order consequently goes unfilled.
A limit order is like a market order with one exception, price takes the highest priority. For limit buy orders, the customer includes, along with the type and quantity of futures contracts to purchase, a maximum price to pay for the contracts. A customer will use a limit buy order if they desire to buy the futures contract, but want to pay no more than a specified price - the limit price. This price is always below the prevailing market price, since the customer would have otherwise entered a market order. For example, December gold is trading at $395.75 per ounce. A customer who enters a limit order to buy 5 December contracts at $392.00 is willing to buy gold futures only if they can be acquired for $392.00 per ounce. A limit order to buy is only executed if the market price declines to the limit price. Limit orders are assumed to be day orders, meaning that if prices have not declined to the specified limit by the end of the day, then the order is left unfilled and cancelled.
For limit sell orders, the customer includes, along with the type and
quantity of futures contracts to sell, a minimum price to sell the contracts.
A customer will use a limit sell order if they desire to sell the futures
contract, but want to receive at least some specified price - the limit
price. This price is always above the prevailing market price, since the
customer would have otherwise entered a market order. For example, December
gold is trading at $395.75 per ounce. A customer who enters a limit order
to sell 5 December contracts at $398.00 is willing to sell gold futures
only at a price of $398.00 per ounce or higher. A limit order to sell is
only executed if the market price rises to the limit price.
A stop order, like a limit order, is only executed once a specific price is reached, but the motivation for the transaction is different. Whereas the limit order is typically used to enter into a futures position at a specific price, a stop order is usually used to exit or close a futures position at a specific price. Stop orders are most often used to close a position that is losing money, and are hence regarded as a useful risk management tool. A stop order to buy has a price that is above the market price and would be used by a customer having a short futures position. If prices rise so that loss accrues on the customer's short position, the stop loss provides a limit to the loss - as soon as prices rise to the stop price, the order is executed as a market order. For instance, with September Canadian dollar futures at $.7225, a customer who is short 10 futures might enter a stop loss order to buy 10 September Canadian dollar futures at $.7300. If prices rise to the stop price, the order is executed as a market order and the resulting long position offsets or closes out their initial short position. Similarly, a stop order to sell has a price that is below the market price and would be used by a customer having a long futures position. If prices fall so that loss accrues on the customer's long position, the stop loss provides a limit to the loss - as soon as prices fall to the stop price, the order is executed, thereby closing out the initial long position.
Stop orders do not guarantee that the loss on a futures position will be confined to the stop price. Prices may continue to move adversely as the stop order is being executed resulting in larger loss than anticipated. This should be taken into account when using stop orders as a risk management tool.
| The Market Order | The Limit Order | The Stop Order |