I recently received an email from one of my Singapore students who had a very good question about using Stops in the Futures markets:
I am Tan, one of your Futures students from Singapore. I recently read a new CME rule which says that a stop order in the grain markets automatically becomes a stop limit order with the limit price being 5 cents away from the trigger price. Is there a way to always use a stop market order and does this rule apply to all the markets? Thank you very much!
I would like to thank Tan for his email, but mostly I would like to say how happy it makes me to see a Futures trader expanding his knowledge base outside of just looking at charts. Charts might be where we make our buy and sell decisions, but understanding the products and Exchange rules we trade is vitally important. Keep up the good work Tan!
Electronic trading has brought many changes to the way we trade today’s Futures markets. Not only have they brought these changes they are constantly evolving to keep up with the demand around the world of Futures traders. Believe it or not, electronic trading is still in the infant stages of where it needs to go and will eventually go.
While there are so many changes in electronic trading I would like to address Tan’s question about Stop Market orders in this article.
Let’s say you were trading the Corn contract and you routed your order to the trading pits at the CMEGroup Exchange. Perhaps you see price leaving your level after you shorted the market and you decide to place a “stop market” order to protect your position. Your Stop Market order would be in the hands of a floor broker in the Corn pit where he will “bid” your contract to buy if the market trades up to your Stop Market price. In the event price does trade up to your price the following will happen. Once the market trades at your Buy Stop Market it becomes an instant Market Order. Meaning you are guaranteed a fill of your order, but not a specific price. In front of him will be floor traders who act as market makers on the Exchange floor. A floor trader will make a current “offer” to sell your contract usually just over the last price. The floor broker will then sell your contract to that floor trader who will buy it.
This seems like an orderly process, right? Well, in this example there was no bullish news just hitting the wires causing the Corn market to turn “bid” (excessively more buyers than sellers). If this had been the case your Stop Market order could possibly be filled at “any” price at or above your specified Stop Market price. Any price fill higher than your specified Stop Market price is referred to as slippage.
Depending on the type of news and the Corn market structure it is possible to have initially only had a potential $200 risk and when your order finally gets filled you could have lost $250, $375, $425 etc. This is because your Stop Market order became an instant Market order once price traded at it. The floor traders all raised their offers (sell prices) once the bullish news came out, therefore nobody was willing to take the other side of your trade until price was at a higher market value making it a better selling opportunity for the floor trader.
Even today this is how a Stop Market or Market order is treated in the trading pits when orders are executed in the open outcry process. Basically there is no limit to your risk using Market type orders.
Electronic trading has a different way of treating “all” Stop and Market orders on both the CME Globex Platform and the Inter-Continental Exchange (ICE) Electronic trading platforms. To prevent excessive slippage when something shocks the market the Exchanges have implemented rules using Price Banding and Protection Points.
From the CMEGroup website they describe Price Banding:
Futures Price Banding
A Price Band Variation (PBV) is a static value that varies by product. It is symmetrically applied to both the upside (for bids) and downside (for offers) to determine the Price Band Variation Range (PBVR). With each price change the PBVR is recalculated and the new range is applied. The CME Globex platform rejects all bids and offers outside the PBVR.
Applying the PBV to a reference price determines the PBVR. The reference price depends on the market state and trading activity:
- During the Pre-Open and the Pre-Open/Non-Cancel period, the contract’s Settlement Price is the reference price.
- Once the first Indicative Opening Price (IOP) is calculated, it becomes the reference price.
- During trading hours, the Last Price is the reference price.
- If no IOP or Last Price is established, the Settlement Price remains the reference price until a Last Price is established.
- In the event of a market emergency, when a market is placed in a non-trading mode during trading hours, the IOP serves as the reference price during the non-regular Pre-Open and Pre-Open/Non Cancel Period. If no IOP is available, the Last Price is the reference price.
Price Banding basically sets a maximum amount a market can actually trade in just one tick from any of the listed price origins above. All Futures markets have these PBV’s and their respective values. If price did trade outside this band in one tick the trades would not be honored. Remember these moves would have to come from just one price change not a series of changes. The Corn market has a PBV of 9.75 cents, if Corn was trading at 410’0 and the very next trade came at 398’0 due to market participants pulling their bids then any trades beyond the PBV would not be honored (410’0 – 9’6 = 400’2).
Think of Price Banding as a Limit Move from one price tick to the next. The other part of this is Protection Points (PRT). The CMEGroup describes a PRT as:
Protection Points for Market and Stop Orders
Functionality in the Globex platform permits Market Protected and Stop Protected orders to be automatically assigned a limit price from a pre-defined value without the user having to manually define the limit price. The Protection Point (PRT) values vary among products and are subject to change (for Stop Logic and PRT values, please refer to the link below). The Match Engine calculates the Limit Price by adding/subtracting the PRT value to the opposite best bid or offer price in the market for a Market Protected Order and by adding/subtracting the PRT value to the Trigger Price for a Stop Protected Order. Any unmatched remaining Quantity for a Market Protected or Stop Protected Order will become a Limit Order at the Limit Price assigned by the Match Engine.
Unlike Stop Markets and Market orders placed in the trading pits, “ALL” Stop Markets and Market orders placed on Electronic platforms are actually a form of Limit orders. All markets have their own specific PRT’s just like they all have their own Price Banding prices. These rules are to help protect investors against flash crashes on Electronic trading platforms especially during low liquidity times of the trading session.
As an example of these rules being elected, let’s look at an example in the Corn market.
Say you had a long swing trade position in the March Corn market at $4.10. During an ETH session some news occurs that causes a flash crash resulting in a downside gap of 20 cents making the last price $3.90, all in one tick. As is the case after most panic moves the market bounces back to about $4.02.
If you had a Stop Market at $4.04 prior to the flash crash your fill price would probably have been around the $3.90 area, causing you to have a lot of slippage on the trade. These types of moves are not uncommon during low liquidity times of the day.
Fortunately the CMEGroup and the ICE Exchanges implemented Stop with Protection rules to protect against these erroneous moves. So how do these rules protect the investor?
If you have your sell stop set to $4.04 for your Corn trade and the market touches it then according to the Stop with Protection rules it becomes a sell Limit order 5 cents under your original Stop. This will make your order look like a sell limit at $3.99. A Limit order is defined as “at this price or better”. Your stop will have to be filled at or above $3.99, allowing you 20 ticks in the Corn market to find somebody to take the other side of your trade. The majority of the time you will be filled at your stop price or a few ticks away.
Unfortunately there could be times when the market will gap through your Limit of $3.99 as in our Corn trade where it gapped to $3.90 and you will not be out of the market. Imagine that price just jumps over your Limit order thereby skipping it. Now your $3.99 price is waiting in the market as a Limit order to be filled when price trades back up to $3.99.
Once price trades to $3.99 your Stop with Protection Limit is filled here instead of the original $4.04.
The link to find these Price Banding and Protection Points is here:
Once here scroll down to GCC Product Reference Sheet. XLS
The Spread Sheet has all of the Futures contracts on the CMEGroup Exchange. You may have to scroll down a long ways to find the market you are looking for, but they are all there. These are subject to change.
The CMEGroup and ICE Exchanges only take two types of Stop orders :Stop Limit and Stop Market with Protection. Regardless of what your trading platform calls your Stop orders they all go in as a form of a Limit order during the entire trading session, both Regular Trading Hours (RTH) and ETH.
These are some very important rules to be aware of. I know many traders who load up there platforms with open orders and leave them sitting there waiting for price to come back. The problem with this is what happens when a flash crash occurs while you are away from your screen and now you have so many open positions that have jumped their Stop with Protection Limits? Some people might say “This will never happen to me,” but it only takes one event like this to wipe out a trading account. Not trying to scare anybody, but we live in a world where anything can and does happen at a moment’s notice and we must be prepared to handle it.
It’s been a great year traveling and instructing for Online Trading Academy and having the opportunity to meet so many of you in our classes.
“We often take for granted the very things that most deserve our gratitude.” Cynthia Ozick