By Don Dawson, Online Trading Academy Commodity Futures Instructor
Happy New Year!
Here we are in a new year and the trading only looks more and more promising as we go forward. Soon the major market participants will return from their year-end holidays and begin placing large amounts of capital to work. A seasonal tendency this time of year is for retail investors to place large sums of money into the stock market from year-end bonuses, especially after such a large rally off the lows in 2009. After all, the monthly chart of the SP has 10 green monthly candles off the lows and only 2 red candles in that run. Can you see investor "Joe Retail" looking at his charts thinking how he needs to get long (needs to buy) this market before he misses it? This in turn will create some great opportunities for us Futures traders as the daily ranges begin to expand. As Futures traders, we really don't care if a market goes up or down; we just want it to move!
Futures orders are very similar to Equities orders when executed on the electronic platforms. The electronic platforms only take certain order types. I will list these orders and describe how and when to use them and the pros and cons of each. All of these orders can be used for either entering or exiting a position. Your commissions will be based on the quantity of contracts you are trading. For each Futures contract you execute, you will pay a commission. For example: 3 Futures contracts = 3 round turn commissions. Unlike Equities, where you pay commissions per side, the Futures markets charge a round turn commission that covers both the buy and the sell side of the transaction. All four of the following orders will be charged the same commission.
The four types of orders are:
- Market Order
- Limit Order
- Stop Market Order
- Stop Limit Order
Market Order
A Market Order is an order to buy or sell a Futures contract immediately at the best available current price. These orders can be used to enter the market or exit the market. Electronic platforms will give you an immediate fill price on your order. Keep in mind that there has to always be a buyer (bid) and a seller (offer) at the same price in order to complete a transaction.
When you buy at the market, you will be matched to the ask price which will be at least one tick higher. This is the equivalent of giving up one price tick of profit for the privilege of getting in or out of the market immediately.
When you sell at the market, you will be matched to the bid price which will be at least one tick lower. This is the equivalent of giving up one price tick of profit for the privilege of getting in or out of the market immediately.
I would not recommend using Market Orders on a regular basis. Think about the tick you are giving up for each time you get in and out of your trades. In the ES, for example, if you traded 5 times per day at $12.50 per tick you are giving up a total of $62.50 per day. Then if you annualize that, you will give up $15,312.50 per year! That figure is if you only entered your trade with a Market Order. If you used it to enter and exit, you are giving up $30,625.00 per year.
Your trading platform will usually have buttons labeled "Buy Market" or "Sell Market." Be careful with your mouse around these buttons. Just one click and you could exit a good trade too early or be put into a position when you did not intend to.
Market Orders are usually used when a trader sees the market prove itself and then they enter the market. Market Orders used for exits are usually selected when the trader wants out immediately.
My use of Market Orders is very rare, usually reserved for bailing out of positions when something has gone wrong. For example, if the power or broadband goes out and back on, or some catastrophic news event happens that shook the market, or anything else that is out of the norm. I hit the Market Order button first to exit, then I look for answers as to why this event happened.
Pros |
Cons |
Immediate execution |
Cost of using on a regular basis |
Will always be filled |
Using Market Orders can be a sign of trading with emotions by chasing the market |
Figure 1
Limit Order
A Limit Order is an order to buy a Futures contract at no more, or sell at no less, than a specific price. Limit Orders can be used to enter or exit the market. I prefer to enter my trades with a Limit Order. This way I make the market come to my price or else I am not interested in the trade. I set Limit Orders at some of my profit exit points. While the price is moving towards my exit Limit Orders, I use a trailing stop to lock in profits in case the price does not reach my Limit Order.
Limit Orders are usually used when you have selected a Support (Demand) / Resistance (Supply) level and you are waiting for the market to come back to your price. These are also known as Resting Orders above (sells) or below (buys) the market. This allows the trader to set their price and have control over the price they will receive if filled. Using these types of orders will give you control over price, but not necessarily execution.
A buy Limit Order can only be executed at the Limit Order price or lower. For example, if a trader wants to buy the ES contract, but does not want to pay more than 1122.00 for it, the trader can place a Limit Order to buy the ES at 1122.00 "or less." The use of a Limit Order to get your price instead of a Market Order will make the market come to you instead of paying a higher price, but risk not being filled if the price does not come back to your price.
All buy Limit Orders are placed below the current market price, in the bid column (usually blue). Today's platforms will not allow you to place a buy Limit Order above the current market price.
A sell Limit Order can only be executed at the Limit Order price or higher. For example, if a trader wants to sell the ES contract, but does not want to sell for less than 1122.00, the trader can place a Limit Order to sell the ES at 1122.00 "or more." The use of a Limit Order to get your price instead of a Market Order will make the market come to you instead of selling at a lower price, but risk not being filled if the price does not come back to your price.
All sell Limit Orders are placed above the current market price, in the ask column (usually red). Today's platforms will not allow you to place a sell Limit Order below the current market price.
Pros |
Cons |
Makes market give you your price or better |
Price may not reach the Limit Order |
Eliminates slippage on orders |
If market is moving fast, there is a chance the price could hit your Limit Order and still not get filled |
Figure 2
Stop Market Order
A Stop Market Order (a.k.a. Stop Market Loss Order) is an order to buy or sell a Futures contract once the price has reached and touched the Stop Market Order price you entered. Once the price is touched, your order becomes a Market Order. This means you are guaranteed to get filled, but you may not get filled at your requested price.
The trading Matrix will have a selection under "Order Settings" to select what type of Stop Order to use. Your choices are "Stop Market" and "Stop Limit" (explained later). I would highly recommend you to "ONLY" use a Stop Market Order for exiting your positions. This way you are guaranteed to get a fill price, unlike using a Stop Limit.
Stop Market Orders can be used to enter or exit a position. Below are some examples of using Stop Market Orders.
Figure 3 Around 11:30am the market was trading near 1110.00. If you wanted to be long (buy) this market, but you wanted the market to go in your direction first, you would place a buy Stop Market Order just above the Swing High at 1113.00. As long as the price does not trade at 1113.00, you have no position in the market. Once the market traded to your Stop Market Order Price of 1113.00, the order would become a Market Order and you would be guaranteed a fill, but the price may be different than 1113.00.
Figure 4 Around 9:30am the market was trading near 1116.50. If you wanted to be short (sell) the market, but you wanted the market to go in your direction first, you would place a sell Stop Market Order just under the Swing Low at around 1115.00. As long as the market does not trade to your Stop Market Order of 1115.00, you have no position in the market. Once the market traded to your Stop Market Order Price of 1115.00, the order would become a Market Order and you would be guaranteed a fill, but the price may be different than 1115.00.
Figure 5 Stop Market Orders are also used to control the amount of risk you are willing to take on each trade. In this example, we went short (sold) around 1110.00. Once we enter this position it is very important to place a Stop Market Order to limit the risk for this trade in case the market does not go in our direction. Since we were short (sold) our Stop Market Order, will be a buy. We will place a buy Stop Market Order just above the swing high around 1112.00. As you can see, the market traded up to our buy Stop Market Order and once the market traded at 1112.00, the order became a Market Order and was filled immediately. If the market had continued higher, we would have been out of the market with no extra risk to our trading capital. This same type of Stop Market Order is used if you were long (buying) the market and needed to protect yourself with a sell Stop Market Order.
Pros |
Cons |
Once price is hit, execution is guaranteed |
Execution is guaranteed but not price |
Can enter market once it starts in your direction |
Using Stop Orders for breakout trading can make you late entering a move |
Figure 6
Stop Limit Order
A Stop Limit Order combines the features of a Stop Market Order and a Limit Order. Once the stop is reached, the Stop Limit Order becomes a Limit Order instead of a Market Order (as in the previous Stop Market Order), to buy (or to sell) at no more (or less) than your specified price.
These Stop Limit Orders work well in fast moving markets when you are trying to enter the market on a breakout. The limit portion of the order will restrict how much slippage you can get on the fill. In some less liquid markets this can be several ticks before you actually get filled. One problem with these orders is that the market can trade through them very fast and the limit portion of the order may restrict you from getting filled. So you miss entering the trade. There is actually a trade-off here. If the market went through your level that fast and did not fill you using a Stop Limit Order, the chances are that if you had used a Stop Market Order, the slippage would have been terrible. This could cause you to get a very bad fill price and, therefore, making you risk more than your initial risk.
For the reasons stated above, I would absolutely never use a Stop Limit Order to protect against a loss in the market. If you were long (bought) the market and place a sell Stop Limit Order under your entry price for protection, the market could easily trade through your Stop Limit Order and not get filled, leaving you still long the market with absolutely no protection against losing large amounts of capital.
Markets such as the Russell, Gold, Crude Oil, Currencies (except the Euro) and other relatively illiquid markets should use Stop Limit Orders to enter positions if you are not using a Limit Order already.
Pros |
Cons |
Reduces slippage on entry in less liquid markets |
No guarantee that order will get filled |
Figure 7
These are the most popular order strategies used on electronic Futures platforms. You can see each one has their strengths and weaknesses. Part of your trading plan is to identify which one works for you and what you are comfortable with. Then use it on a consistent basis to obtain positive results.
Good trading,
- Don Dawson
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