Forex Secret Tips No 38 - Grasp The Basic Order Types For Your Forex Trades
The takeaway Forex trading tip from this article is: get a good grasp of the basic Forex order types and apply them correctly to your Forex trading. They can help you understand the various complex orders and equip you with knowledge to create customized orders too.
There are several ways to open and close your Forex trades, depending on how you plan to enter and exit the markets. The three basic Forex order types are: market order, stop order and limit order. Each order type can apply to both trade opening and closing.
Remember that a Forex quote has a bid and ask price. When you issue a buy order, you pay the ask price of the Forex quote; when you sell, you hit the bid price. The difference between bid and ask prices is called the spread -- this is what your broker earns each time you trade.
Take an example where EURUSD is currently quoted at 1.3388/1.3390. If you open a long position (i.e. you buy EUR, sell USD), you would pay 1.3390 to get into the markets. Should you decide to close the position immediately, and assuming prices did not move, you can only sell back at 1.3388. The 2-pip spread in this trade is pocketed by your Forex broker as commission. Which means just to break even requires prices to tick up 2 pips, in your favour.
Now for the basic Forex order types, starting with the straightforward market order. This is followed by the easy limit order, and lastly, the more confusing stop order. The combination of these order types into complex Forex orders is also covered briefly.
** Market Order **
The market order allows you to trade at the current prevailing price. At the instant your order reaches the broker, you are filled based on the Forex quote then and there. This may not be the quote you saw on your trading terminal when you issued that market order, depending on how fast the markets were moving and how long it took for the Forex order to get routed.
In the nutshell, a market order means "Get me filled, now!"; hopefully at your desired price and if not, at a reasonable price.
** Limit Order **
This order allows the Forex trader to set an exact price to fill an order. A buy limit order is always set below current prices and a sell limit order always above. Contrast this with stop orders, which will be discussed later, where the price levels are at opposite locations.
In case you issue a limit order wrongly, you could get filled immediately, depending on how your broker processed the order. To illustrate, if EURUSD is now quoting 1.3385 ask and a trader enters a buy limit order at 1.3390, the order gets filled at the better price of 1.3385.
The main use of a limit order is to set a target price for a Forex trade, so that profits can be banked in automatically once that target is reached. In the case of a trade with multiple positions, setting tiered limit orders can allow the Forex trader to cash out progressively as prices continue to move in favor of the trade.
** Stop Order **
A stop order enables you to take a Forex trade in the same direction as prices are moving, but only when a certain price level is hit. Thus, when you intend to buy, you place your buy stop (order) above current prices. Then you would wait for prices to move up and hit the price level you specified in the stop order.
When selling, the opposite is true, so you would place the sell stop below current prices and wait for prices to go down there. Once the stop level is hit, a stop order becomes a market order automatically -- you could be filled at your specified price point, usually but not always.
It might seem strange why anyone would use a stop order and wait for prices to move there, rather than buy or sell immediately. The reason is that various Forex strategies will only trigger trades when certain conditions are fulfilled. Getting in later rather than earlier allows the trader to join the ride as a price move gains momentum in the intended direction.
For example, you could be waiting for a range breakout either way, so you would set a buy stop above the range high and another sell stop below the range low. Or if you are trading a trendline or moving average breach, you would place the stop order above or below, for buying and selling respectively.
The other use of a stop order is for protecting your position. For every Forex trade entry that results from a valid trade setup, there will be a price level beyond which the original trade premise becomes invalid. Placing a stop order at this level will protect your trading capital from ruin by getting you out of a failed trade immediately when prices hit the stop.
For instance, you could place a sell stop just below the recent swing low when you take on a long position. Or you would place a stop order in the middle of a range once a breakout has occurred, such that if prices ever crept back that much into the range, the trade idea is invalidated and you cut loss.
** Complex Orders **
On most Forex trading platforms, there are complex order types like OCO, contingent order, etc. These complex orders are essentially a combination of the basic order types described above. For example, the OCO, acronym for the one-cancels-other order, is a set of two orders: a limit order and a stop order. When either limit or stop order is filled, the other order is canceled.
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