While most novice investors believe that buying a financial asset is as simple as picking an asset and choosing to buy or sell, there are a few things to be aware of and exercise caution in the process. It starts with understanding the different order types and how each can play a beneficial role in your strategy. There are three main order types that investors should be familiar with.
Market Order: A market order is an order placed by a trader for immediate execution at the current or best available market price on the trading platform.
Limit Order: A limit order is considered a conditional order that depends on the price of an asset reaching a certain level before the order is triggered and ultimately executed. These orders can be divided into "Buy Limit" and "Sell Limit" orders. A buy limit order is an order to buy an asset at a price lower than the current market price. Once this price level is reached, the order is processed and the trade is opened simultaneously. A sell limit order is an order to sell an asset at a price higher than the current market price. Once this higher price is reached, the order is triggered and a short position is opened.
Stop Loss Order: Like a limit order that will open a position when the price of the asset meets certain conditions set by the order, a stop loss order will only be triggered when the price of the asset reaches a certain level. In the case of a buy stop order, the order to buy the asset is placed above the current market price. Go long and open a position when the price of an asset rises and a buy stop order is triggered. Conversely, a sell stop order opens a position at a price lower than the current market price. When the asset price falls to this level, the order will be executed and a short position will be opened at the predetermined level.
Limit and stop orders also form the basis for some of the more advanced order types used to manage risk and reward. These include take profit orders (a type of limit order) and stop orders (a type of stop-loss order), the former automatically closing a profit when open trades reach a certain level, and the latter at a pre-set point to close the position at a loss.
There is also a trailing stop, which is another type of stop-loss order that tracks the market price. If a trailing stop is set as a long closing trade, it will follow the market price as the asset price rises and will be triggered when the asset price reverses. A trailing stop can be set to close a trade at a loss or profit, depending on how it is set.
Why use different order types?
Limit and stop orders are particularly useful, and may even be more valuable than market orders, because they allow investors to clearly define when and where they intend to step in. Even better, they can help investors time their trades by identifying more potentially favourable opening and closing points without constantly monitoring the market.
Sometimes the excitement around changing conditions and prices is an attractive reason to get involved. Often, however, getting caught up in this excitement leads to poor decisions and rushing into positions, rather than carefully planning trades and preparing for different outcomes. Rather than rushing into positions, buying high and selling low, and predicting the wrong direction, wait patiently and place conditional orders at important price levels. It can help you manage risk and build more attractive entry and exit strategies.
