Explanation of Order Types

Posted on 16th Aug 2015
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Explanation of Order Types - India Stock Market Let's understand how is trade and order related to each other. A trade is basically made up of at least two orders viz a buy order and a sell order. Usually one order to enter the trade and one or more orders to exit the trade. A single order can be a buy order or sell order and it is used to enter or exit a market. If a trade is initiated with a buy order than it will be exited by sell order and vice versa.It is important to know how to trade and which order type is appropriate for a given situation. Traders have access to many different types of orders that they can use in various combinations to make their trades. Here I am trying to explain various order types and let you decide which order type or combination suits your trading style.

1. Market order:

A market order is the most common type of trade order. It instructs a buyer to buy shares at currently available prices rather than any particular price that you have in mind. The transaction will take place as soon as you place the order, required there are sellers available in the market.

Pros of market order:

It has the surety of completing the trade. The trader can come in and out of trade using market

Cons of market order:

When you place a market order, you will never be sure of the price at which it would transact, and there are chances it can lead you to losses especially if you are an active trader. A market order does not guarantee the price, it only guarantees the execution of the trade.

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2. Limit order

A limit order is an order to buy or sell a stock at a specified price or better. Unlike market order, in a limit order, a trader has to specify a desired price to buy or sell the stock. A buy limit order can only be executed at the specified price limit or lower. Alternatively, a sell limit order can only be executed at the specified price limit or higher. The important thing to keep in mind while placing a limit order is that you have to enter a limit order to buy at or below the current bid and enter a limit order to sell at or above the current ask price.

Pros of limit order:
  • The limit order prevents you from losses.
  • The limit order allows a trader to enter and exit trades with precision.
Cons of limit order
  • If the price does not fall to your desired quote then you will not get the shares.
  • It does not guarantee the execution of the trade. The trade may not takes place if there are not enough buyers or sellers even though the market has moved to your specified limit price.
Note: The limit order stays valid only till the end of the current market session. After the market closes, the order is canceled. You will have to place a new order the next day.

3. Stop Loss order (SL) or Stop Order

Stop loss order is an order to limit the losses by defining our limit past which we don't want to risk any more money. We can protect ourselves by initially defining what would be the worst possible loss we are willing to take in any trade. As soon as the trade is executed, we can place the stop-loss order in the market. Stop-loss order works opposite of limit order. A buy stop order is placed above the current market price and sell stop order is placed below the current market price. A stop-loss order is a passive order, to make it active, we have to set a trigger price which is a price just above the stop loss price. Its a threshold price which after crossing only the stop-loss order becomes active.

Let's take a scenario here to understand it clearly:

Suppose you buy a share of Infosys at 400 with the expectation that it will go to 430 in near future. But let's assume that the price starts going down. Here we can protect ourselves by taking into account how much loss we are willing to take. Let's assume the buyer doesn't want to risk himself below 385. Therefore 385 is the stop loss price. To get this price active you have to set a trigger price which has to be higher than the stop-loss price. We can set this to Rs 389. If the price drops to Rs 389 from 400, the stop loss order gets active.

Pros of stop-loss order:
  1. With stop loss order, you can set a limit of risk you are willing to take for a trade.
  2. For long positions or sell order, the initial stop-loss is set below the current price, providing protection in case if the market drops.
  3. For short positions or buy order the initial stop-loss is set above the trade entry in case the market rises.
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What is "trailing stop"?

A trailing stop is a stop order that can be set at a defined percentage to protect gains by enabling a trade to remain open and continue to profit as long as the price is moving in the right direction, but closing the trade if the price changes direction by a specified percentage. A trailing stop for a long position would be set below the stock’s current market price. For a short position, it would be set above the current price.

What are SL and SL-M?

The difference between SL and SL-M is that when the trigger price is hit, the stop-loss order is sent as a limit order with the limit price mentioned by you in the SL order, whereas in SL-M, the order is sent to the exchange as a Market order.

4. Cover Order

In cover order, you take an opposite position (stop-loss) to close your open position created by the fresh order. Assuming you have taken a buy position, your cover order will naturally be a sell order and vice versa. CO is an Intra-day product with one additional information which is stop-loss.  Stop-loss is the limit of loss you are willing to take in case trade moves against your directional view.  In CO you can place intraday buy/sell market orders with a compulsory stop loss for higher leverage.

5. Bracket Order

It is a type of order where you place three orders on one go. The first order is to enter a new position. The 2nd (or Profit Book order) and 3rd (or Stop Loss) order are always in the opposite direction of the 1st order and will book you a profit or cut loss on your 1st order respectively.  As soon as the main order is executed the system will place two more orders (profit taking and stop loss). When one of the two orders (profit taking or stop-loss) gets executed, the other order will get canceled automatically. If the profit book price of the square off/cover order is reached first, the profit book or 2nd order will get executed and your position will get squared off with a profit being booked. The stop-loss or 3rd order will simultaneously be canceled. 

If however, the stop loss price is reached first, the stop loss or 3rd order will get executed and your position will get squared off while limiting your loss. The profit book or 2nd order will simultaneously be canceled.

6. After Market Order (AMO)

After Market order as the name suggests is the type of facility you get to place an order after market hours. AMO orders can be placed any time between 4:30 PM to 9:00 AM (little variation depending from broker to broker). AMO is especially beneficial for traders who do not get time to trade during market hours due to office constraints. You can place either Limit Order or Market Order under AMO.

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