What is an order in trading and how many types of orders are there?
Every order specifies key details: the asset you want to trade, whether you want to buy or sell, the quantity, and sometimes the price. This information allows your broker or exchange to match your order with another trader’s on the opposite side of the market.
How do trading orders work?
Placing an order is a straightforward process. On the trading platform, you will see a simple order form. Fill in the details, such as the asset, whether you want to buy or sell, how many units, and the type of order. Once you submit this form, it is sent to a central system called an order book. The order book is a list of all buy and sell orders for a specific asset.
For example, in the stock market, the order book shows the number of shares of a stock people want to buy at different prices and the number of shares people want to sell at different prices. The exchange’s system then tries to match your order with a corresponding order on the opposite side of the market. This process is called order execution.
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Types of trading orders explained
Different types of trading orders serve different purposes.
Market order
This is the most basic and common order type. A market order is an instruction to buy or sell a security immediately at the best available current market price. It guarantees order execution but not the price. For example, if you want to buy 100 shares of Apple stock right now, you’ll place a market order.
Limit order
This is an order to buy or sell at a specific price or better. It gives you control over the price you trade at. If you want to buy a stock but only if the price drops to a certain level, use a limit order.
Stop order
A stop order is a type of order that becomes a market order when a pre-specified ‘stop price’ is reached. There are 2 main types of stop orders:
- Stop-loss order: used to limit potential losses. You set a stop price below the current market price. If the price drops to that level, the stop order is triggered and becomes a market order to sell.
- Take-profit order: used to lock in profits. You set a stop price above the current market price. When the price rises to that level, the order is triggered and becomes a market order to sell.
Other important order types
- Day order: this type of order remains active until the end of the trading day. If it isn’t filled by then, it is automatically cancelled.
- Good 'til date (GTD) order: GTD orders remain active until a specific date. They are useful for trades you want to make over a longer period.
- Intermarket sweep order (ISO): an ISO is a special type of limit order used for trading on multiple exchanges simultaneously. It is often used by institutional traders to execute large orders.
Active vs. passive orders
Orders can also be classified as active or passive. Active orders, such as market orders, are aggressive. They are designed to be filled immediately. They ‘sweep’ the order book for the best available price. Passive orders, like limit orders, are not aggressive. They wait on the order book for a matching order to come to them.
These terms are important to know because they are the trading essentials required to communicate in the markets.
Why use different order types?
Using different order types is essential for effective risk management and achieving specific trading goals. They give you control over your trades. For example, a stop-loss order automatically sells a stock if its price falls too low, preventing a big loss. A take-profit order helps lock in gains before the market reverses.
However, using different orders also comes with challenges. Slippage is a major issue. This occurs when the execution price is different from the expected price. It often happens with market orders in fast-moving or low-liquidity markets. The price can change between the time you place the order and the time it is filled. Liquidity is another challenge. A lack of buyers or sellers can either lead to slippage or prevent your order from being filled at all.
How to choose the right order type
Choosing the right order type depends on your trading strategy and your risk tolerance. For instance, if you prioritise speed and guaranteed execution, a market order is a good choice. If you are more patient and want to control the price you trade at, a limit order is the way to go. If you are a swing trader or a long-term investor who cannot monitor the market constantly, stop-loss or take-profit orders are crucial for risk management.
Pros and cons of different orders
Each order type comes with advantages and disadvantages. Market orders have the benefit of guaranteed, fast execution. But they do not provide price control. There is also the risk of slippage, especially in volatile markets.
Limit orders offer price control and prevent slippage. But there is no guarantee of execution, so you may miss out on trades. The advantage of stop orders is that they automate risk management. However, they can be triggered by temporary price spikes, potentially for a worse-than-expected fill price.
Day orders are simple. Automatic cancellation prevents long-term unintended exposure. However, they must be re-entered if not filled. Finally, GTD orders allow for long-term price targeting without constant market monitoring. The problem is that you might forget about them, leading to an unwanted trade later.
What are the risks of using different order types?
Using trading orders is not without risk. Here are the most common ones:
Execution risk
This is the risk that your order is not filled as you intended. A market order might be filled at a much higher or lower price than what you saw on the screen a second ago. A limit order might not be filled at all.
Market volatility
In a volatile market, prices can change very quickly. A sudden price drop can trigger your stop-loss order, causing you to sell at a much lower price than you had hoped.
Liquidity
Poor liquidity means that there may not be enough buyers or sellers to fill your order. This could either lead to slippage or unfilled orders.
FAQs
What is a market order?
A market order is an instruction to buy or sell a security immediately at the best available current market price.
How does a market order work?
When you place a market order, it becomes part of the order book. The system immediately fills the order by matching it with the best available opposing order on the order book.
What is a stop market order?
A stop market order is an order to buy or sell a security that becomes a market order once a specific ‘stop price’ is reached.
What are the risks of using limit orders?
The main risk of using a limit order is that it may never be filled. If the market price of the asset never reaches your specified limit, your order will simply expire without a trade being made.