Demystifying Order Types: Market Order vs. Limit Order
If you experience a significant amount of slippage on your positions there are a few things you should know:
First, check with your broker to see if they house the orders on the exchange or on their own servers. If you’re trading futures using Infinity Futures you’re set, they do. Make sure you are using a reliable futures broker.
Second, know the difference between market and limit orders and which situations they are best called for. Knowing the difference will help you get better fills, see less slippage, and take fewer stop outs.
What Are Market Orders?
These orders are great for exits, but dangerous for most entries. This is because a market order is an order to buy or sell at the market, whatever that current price may be. We all know that the markets move incredibly fast so when you place a market order or click the join bid/ask you are essentially throwing your hands up in the air saying “I don’t care at what price I get filled.”
Is there a better option?
What Make Limit Orders Different?
Yes. The way to get better fills is to use an order type foreign to most traders, limit orders. This ensures that you will get filled at your price or better because a limit order is instruction to do just that, “buy or sell at the price you select OR BETTER.” This means you cannot get filled for anything worse than where you place your order.
When to NOT Use Limit Orders
There is one instance that you would not want to use a limit order, when placing stops. A stop order is saying, “When price touches this level I want to close out my position at the market.” For most order execution platforms a stop order is by default a market order.
If you were to use a stop limit order and price were to quickly move through your stop price, you would remain stuck in the position. Think about it. That limit order is saying, “I want to get out at this price or better” so if you’re long with a stop below you and the market quickly moves through your stop limit order, the order will stay active and not fill you, very dangerous.
Tips for Breakout Traders
If you are the type of trader who likes trading breakouts, instead of waiting for price to breakout and then clicking the market button consider using buy stops and sell stops. This is one instance where it IS okay to use market orders for your entry.
While this order is a market order, placing it well in advance will help reduce slippage because most platforms use a FIFO, (first in, first out) method.
This means if you place your order sooner than the next trader, you will be filled first. If you wait for that breakout and then hit the market button you will be last in line.
This is where the power of limit orders really shines. If you’re the type of trader who likes to buy or sell when price has retraced of its highs or lows, using a limit order will ensure that you will get filled at your price or better.
Waiting for price to retrace can help reduce the number of stop outs you take. The reason being, you are not impulsively jumping in at highs, you are waiting for that pullback in the larger trend and as that counter trend trade loses steam, you enter in anticipation that the market will resume in the current direction.
Using Limit Orders to Reduce Impulse Trades
In my Traders Expo talk on “Costly Trading Mistakes” I talk about the dangers of impulse trading (here’s the re-recorded video presentation). Limit orders can help reduce impulse trading because you are identifying and setting your order well in advance.
One con about using limit orders is that if price does not go beyond your order you will not be filled. This however, can be looked at as a good or bad thing.
Limit orders ensure you get filled at your price or better, and I’d rather trade in this way missing a few trades, than taking stop out after stop out by impulsively clicking the market order button.
What’s your view? Do you use market or limit orders, and why?