During his recent Business and Investing Mastery Event, Darren Winters emphasised to his eager attendees that, understanding the difference between a market order, limit order and stop loss make up the fundamentals of developing the trading skills and strategies for different market conditions.
In a typical market transaction, the vendor makes a price for his goods or services and the buyer agrees to pay that price.
But not all transactions are that straightforward. For example, with a car, you can either pay the price displayed on the windscreen and drive away with the car as the new owner. Alternatively, you can negotiate a price and refuse to finalize the deal unless the dealer meets your price.
The financial markets work in a similar way. In other words, traders can transact through their brokers using a market order, limit order and stop loss order
Darren Winters defined a market order, a limit order and a stop loss order for his Business and Investing Mastery Event attendees.
What is a market order?
A market order is the most common order used to purchase a financial security.
Let’s assume that a trader places an order with his broker without specifying any restrictions, then by default that order is said to be a market order. Market orders are usually placed with a broker or brokerage service which often charge a commission for making the order.
Market orders are the easiest type of orders to complete, so they usually have the lowest fee charges.
When a trader is placing a market order with his broker it means that he agrees to either buy or sell a financial security at the best available price. This price may not always be the currently quoted price for the security.
So when prices are changing rapidly such as in a fast market, where prices can change in seconds, a security’s price can change substantially between the time a person places a market order and the time that market order is completed.
For example, say you place a market order to go long 100 shares of stock XYZ when the best offer price is currently $10.00 per share. If other orders in the queue are executed before your trade order, the market order may fill at a higher price.
So when can market orders be beneficial for traders?
Traders will use market orders when getting filled is their priority rather than getting a certain price.
Market orders work best when liquidity and trading volumes in the financial security is high. So if you absolutely need to get in or out of a trade, a market order is your best bet.
But using market orders also has disadvantages.
Market orders don’t guarantee price or allow for any precision in order entry.
It is not recommended to use market orders when trading volumes are light or when liquidity is low, for example in the morning. Why?
There can be wide differences between the asking price and the current trading price. Also when a slippage occurs, due to the delay between a trade being ordered and when it is actually completed, market orders can work against the trader.
Slippage is more likely to occur when volatility is high, perhaps due to news events, resulting in an order being impossible to execute at the desired price. In this situation, most forex dealers execute the trade at the next best price unless the presence of a limit order closes the trade at a preset price point. In short, during a slippage, a market order could be filled at a less favorable price.
The Darren Winters investment home study course advice for traders looking to avoid costly slippages is to avoid market orders and always enter a “limit order” instead.
What is a limit order?
A limit order sets a firm price that you are not willing to exceed. So by placing a limit order, you put a ceiling on the amount you are willing to pay.
If you want to buy $1,000 worth of XYZ Company’s stock and you don’t want to pay more than $24 per share, you would place a limit order for $24. If the price of the stock remains at $25 or more, the purchase transaction will not be completed.
In other words, a limit order enables the trader to enter or exit a trade at a predetermined price.
The disadvantage of using limit orders is that the order will not be filled until the price has been reached and that may be never.
What is a stop loss order?
This is when a trader places an order with his broker to sell a security when it reaches a certain price. A stop-loss order is intended to limit an investor’s loss on a position in a security. A stop-loss order can be placed in both long and short positions.
But that is just the textbook theory.
You’ll also need to know the truth about stop losses that nobody tells you – let Darren explain…
You can also learn more about stop losses in the trading risk management section of the Darren Winters Investment home study course.