Part 4 - Learn Forex Trading: Order Types

November 19, 2009 | scorpion

As a forex trader you have recourse to different types of orders in order to enter and exit the forex markets. These different types of orders allow you to specify precisely as to how your broker should fulfill your forex trades. This article explains the different order types that are possible in forex trading and emphasizes the fact that it is important that you place orders with a forex broker in the right way.

Market Order

A Market order is one of the most common types of orders executed in the forex spot market.

A Market order is an order to buy or sell a currency at the best available current market price. In other words, in a market order you buy as per current Ask price and if you are selling it would be as per current Bid price. This is the rule and not a choice or exception. These types of orders can be used to enter a new position (buy or sell) or to exit an existing position (buy or sell).

Currency prices always keep changing with the bid and ask prices often fluctuating considerably. So a market order may not get executed at the last traded price. If the order does not get executed at the last traded price, the broker will usually requote and the trader on his part has to reconfirm the price for the market order to become effective. Generally market orders are favored over other orders with respect to more stable currencies such as EUR/USD.

Slippage

All forex orders including market orders are susceptible to what is called as slippage. Slippage can be defined as the difference between the expected fill price and the actual fill price. Assume you place a market order to buy Euro at $1.3535 (expected fill price). But in reality by the time your order would have actually got filled in or executed, the rate would have moved to say $1.3537 which means there is a difference of $0.0002 (called slippage). This may or may not happen. But the fact is, this often happens even with the best of automatic trading software. Slippage is also referred to as bad fill and generally occurs during volatile market conditions as for instance during economic news releases.

You could say that slippage corresponds to what happens during the few seconds that could elapse between the time of giving the market order command (whether buy or sell) and the actual time when the transaction gets executed (when your order gets filled).

Limit Order

A limit order is an order placed to buy or sell currency only at a particular price and no other price. Just like a market order, a limit order is also executed at the forex spot market. But the difference with the limit order is that the transaction would take place only if the traded currency reaches the limit set by you before you bought or sold.

In other words a limit order helps you to limit the maximum price you pay when you buy a foreign currency or limit the minimum price when you sell a currency. So a limit order protects you, in that you don’t buy a currency for a higher price and don’t sell a currency below a minimum price.

Depending on the direction of the position, limit orders can be either limit-buy order or limit- sell order.

Limit-buy order

A limit-buy order is an instruction to buy the currency pair at the market price if the market reaches your specified price or lower. The limit-buy order price level is always set below the current market price.

Take a look at the following example and learn how to set limit orders when buying a currency? - Assume you want to buy 1 standard lots of EUR/USD. The current bid/ask price on your screen is say 1.3535/38. Then you click on the ask price tab and buy 1 lot of EUR/USD, and then assume you set a limit of 1.3536. This means that unless the ask price is lowered from the current 1.3538 to 1.3536, this transaction will not be executed. So it helps you limit the maximum price you pay when you buy a currency. In this transaction before you place the limit order you have got to reiterate or reaffirm to yourself that you want to buy the currency only if the price were no higher than what you were willing to pay.

As you can see from the above example, the limit order can be used to enter trades. Just set the entry price and the trade will be entered only at that price and no other price.

Limit-sell order

A limit-sell order is an instruction to sell the currency pair at the market price if the market reaches your specified price or higher. Note that the limit-sell order price level is always set above the current market price.

How to set a limit order when selling a currency? – Consider the same EUR/USD example as above. The current bid/ask price on your screen is the same 1.3535/38. In this case you may set a limit order on the bid price for 1.3537 which means you will sell the EUR/USD currency only if it rises to at least 1.3537. So this limit order protects you in that you don’t sell a currency below a minimum price.

As you can see from the above example, the limit order can be used to exit trades making a profit. The sequence is, first deciding your profit set your exit price, and then the trade gets executed only at that price and no other price.

There is a key point to be reckoned with when placing limit orders. For example it is possible that your order may never get executed as the currency price may not reach your set limit order levels. Nevertheless these types of orders are definitely beneficial as when the trade goes through you get the specified purchase or sell price.

To sum up a limit-buy order is an instruction to buy the currency pair at the market price once the market reaches your specified price (lower than current market price). A limit-sell order is an instruction to sell the currency pair at the market price once the market reaches your specified price (higher than the current market price). So limit orders have more to do with profits only.

Stop Order

Now let’s talk of another type of order known as stop orders. A Stop Order (could be either a Sell or Buy Stop Order) which is not executed by your trading platform until the market price has reached your defined price. In other words, a stop order for a currency pair will be executed only when the currency you want to buy or sell reaches a particular price referred to as the stop price. No sooner the currency reaches this price a stop order in effect becomes a market order and gets executed.

The Sell and Buy Stop order is reverse to the Sell and Buy Limit Order. The Sell Stop Order is Always set below the current market price, while the Buy Stop Order is Always set above the current market price. When the market reaches these stipulated prices, it executes and becomes a market order.

Example of Buy Stop order

Assume you expect EUR/USD, which is now at 1.3535 to go up in the next few hours (because of vital economic news releases), but you are unable to keep watch at the trading platform. So what do you do? Set a Buy Stop order and set it at 1.3570. If the market price hits the price, set by you to buy it becomes a market order and execute the deal.

A stop order may be disadvantageous in that it is not guaranteed to be filled at the preferred price you want. Once the stop order gets triggered, it turns into a market order that is filled at the best possible price. Often this price may be lower than the price specified by the stop order.

Stop-loss order

A stop-loss order is akin to a limit order, but importantly it is linked to an open trade and prevents losses should the price go against you. A stop-loss order remains effective until executed or cancelled. Supposing you buy EUR/USD at 1.3535. Therefore, when, you set a stop-loss order at 1.3525 you are limiting your maximum loss. In other words if your calculation went wrong and EUR/USD drops to 1.3525 instead of moving up, the stop loss order will be automatically executed at 1.3525 and close the position for a 10 pip loss. This means you do not have to sit in front of the computer in order to monitor price levels and prevent losses from occurring. Similarly, a stop-loss order can be set on any open position.

Summary of Limit and Stop Orders

Let’s summarize the salient points of Buy Stop Order and Buy Limit Order,

Sell Stop Order, and Sell Limit Order,

Stop orders are where the entry price (buy or sell) is set and is also how we limit our losses. Sell Stop order is set below the market price. Buy Stop order is set above the market price.

Sell Limit orders is set above the market price. However Buy Limit order is set below the market price

One Cancels the Other (OCO) orders are essentially a combination of two limit and/or stop-loss orders placed above and below the current market price. But significantly when one order gets executed the other order gets automatically cancelled.

Consider this example.

Assume that the price of EUR/USD is 1.3535. You decide to either buy say over resistance level at 1.3585 or initiate a selling position if the price falls below to say1.3500. In this OCO Order if 1.3585 is reached, the buy order will be executed and the 1.3500 sell order gets automatically canceled.

So OCO order is a situation when a limit order and a stop-loss order exist at the same time. If any one order is executed the other gets automatically cancelled.

This precludes the necessity for you to continually monitor your currency position in the market

The above are the basic orders types available in most of the trading systems. Understanding the different types of orders will empower you with the right tools to achieve your intentions - how you want to enter the market, and how you are going to exit the market. While there may be other types of orders, market, stop and limit orders are the most common of them all. Largely finding the right type of trading software will also have a major role to play in placing forex trading orders.

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