Market orders are the simplest type of order on the trading markets, generally considered one of the quickest and easiest ways to enter or exit a trade, and an essential part of money management techniques. But what exactly are market orders, and how do they work? Read on to learn the basics on market orders.
What are market orders?
A market order is a request by an investor, usually made through a broker or brokerage service, to buy or sell a security at the best available price in the current market.
If you simply want to deal immediately at the best price available, a market order is the one to use. Provided the market is liquid enough – in other words, if there are enough willing buyers and sellers around at the time – your market order will be executed immediately.
An order that has been executed is called a ‘filled’ order. Market orders are widely considered the fastest and most reliable way to enter or exit a trade, providing the most likely method of getting in or out of a trade quickly.However, it is also important to keep in mind that market orders can be filled at a worse price than the current bid/ask price.
Types of market order
Depending on what you’re trading and how you’re trading it, there are a number of market orders to consider using. Here are just a few examples.
Limit orders
On occasions when you want to wait until a price reaches a more favourable level before you trade, you’ll need to use a limit order.
A limit order is an instruction to trade if a market’s price reaches a particular level that’s more favourable than the current price.
Example
Let’s say GBP/USD is currently trading at 1.5055. Your analysis suggests that if it rises to 1.5065 it’s then likely to fall again, so you decide to sell GBP/USD if it reaches 1.5065.
Rather than sitting in front of your screen monitoring the market, you place a limit order (known as a limit entry order) to open a short trade if the price hits 1.5065.
Two hours later, the market does indeed hit this level. Your broker executes your order and you sell GBP/USD.
Your trade then works in the normal way – so if GBP/USD falls as you predicted, you make a profit. If it continues to rise, however, you make a loss.
As well as using a limit order to open a new trade, you can also use it to close an existing position – protecting your profit if you’re concerned the market might change direction and wipe out your gains.
Stop Orders
In contrast to a limit order, a stop order is an instruction to trade when the market hits a level less favourable than the current price.
Why would you want to trade at a worse price? Well, perhaps the most important reason is to close a position that’s moving against you. To do this, you attach a stop order to the trade. Then, at the point beyond which the level of loss would be unacceptable to you, your stop will pull the plug and close out the position.
When markets are moving very fast it may not be possible to close the position until the price has already passed the level you set, but certainly the stop will give you some protection against escalating losses. Because it helps restrict your losses, this type of stop order is known as a ‘stop-loss’. You can find out more about stop loss orders, and how you can use them as part of wider money management techniques, here.
Example
Let’s say you own 100 shares of ABC Inc. which you bought at $37, and now the price has declined to $35.
You hope this is just a temporary move, but you decide if the price should fall as far as $32 it will be time to cut your losses. You place a stop-loss at $32.
Unfortunately, the price keeps sliding all the way to $27. However, your stop-loss is triggered at $32 and your position is closed.
You’ve lost $500 (100 x $5), but without your stop-loss you would have been looking at a $1000+ loss.
You can also use a stop order to open a new position – known as a stop entry order.
Placing an order to open a trade at a worse price than the current price might seem very strange, but sometimes it can make good sense.
For example, analysis might suggest that if a market hits a certain level it will carry on moving in the same direction. By setting a stop order at such a level, you would be ready to open a position and potentially take advantage of this momentum.
Trailing stops
A trailing stop is a special type of stop-loss – it not only caps losses, but also helps protect any profits you make.
Like other stop-losses, a trailing stop is attached to a trade. If the market price moves in your favour by a specified amount (known as a step), the trailing stop copies this movement. So it keeps its distance from the current price, but step by step it gets closer to the price at which you opened your trade, and may pass it if the favourable movement continues.
However, if the market then turns against you, the trailing stop stays put. This means it can close your position at a more favourable level than a standard, stationary stop-loss would have done – potentially while you’re still in profit.
Example
Suppose you decide to go short on USD/JPY at 117.60. You set a trailing stop 30 pips away, at 117.90. You choose a step size of ten pips.
The market initially drops five pips. As this is less than the step size, your stop stays at 117.90. The price then drops a further five pips to 117.50, triggering your stop to move down to 117.80.
A little later, USD/JPY has sunk to 117.10. Your stop has followed it, and is at 117.40. However, now the market trend reverses and the price rises to 117.50. Your stop remains at 117.40, so your position is closed as the price passes through this level.