Understanding Trade Orders

There is often a lots of confusion between how different orders work and what their characteristics are. This post will serve to try and clear up some of this.

Metatrader 4

Metatrader offers 6 types of orders......well, actually 3 types, but duplicated for Buy and Sell. Be aware that stock trading platforms often have more types of orders although they are commonly combinations of these orders in order to circumvent some of the shortcomings of different order types. These expanded orders are of no interest to us in the MT4 environment.

Order Types

Moving onto our order types. I said we have 3 kinds of orders. This can be broken into 2 groups ie instant orders(buy or sell right now), or pending orders(buy or sell when price hits a defined point).

Most of you will have used market orders already. They are the easiest to understand. You tell the broker to Buy or Sell EURGBP immediately at the best price you can get. The broker fills you at the best available price for your order size and you get an almost instantaneous response from the broker saying that your order has been completed. Easy as pie.

The pending orders are also easy to understand if you look at it in the correct way. We have 2 types of pending orders namely Limit Orders and Stop Orders.

Limit Orders

Let's say you decide to buy a house. You find something nice but it is pricey....$200 000. You decide to submit an offer anyway, of $180 000 in the hope that the seller will come down in price. This would be a Buy Limit Order. Technically, the boffins describe it as a a pending Buy order below the market price(for a Buy). Conversely, let's say you have a fancy car that you wish to sell. The market price is $50 000 but you feel that since it is a classic, you will only sell it for $60 000. You don't care what the market value is, you have put it out there and when someone is prepared to pay your price, you will have a deal. This is a Sell Limit order and is exactly the same principle as the Buy Limit order except your offer is a Sell Order placed above the market price.

Stop Orders

The second type of pending order we get is the Stop Order(used by my EA). Back in 2006 - 2008 Dubai went through a tremendous property bubble. Prices were exploding. A developer would release a tranche of apartments for sale. In the early days, you would have to queue for hours at the launch and if you were lucky you got in and got to buy an off-plan property. You didn't negotiate, you just took whatever price you were given because you walked out and "on-sold" your purchase contract to some-one else still waiting.....of course there was always more than one person and you would sell to the guy offering the most, typically about 5% premium on the purchase price, giving you a hefty profit since you only had to put down a deposit of 10%.

Now why would some-one pay you more than market value(presumably the developer sold at market value)? It is simply because they knew that their purchase would be worth more the next day. They were happy to get in at any price because they knew they were going to make money. The guys standing in the queue and their offers could be considered to be making Stop Orders ie they are making offers at prices above market value. They were making Buy Stop Orders which is where you make a pending Buy Order at a price above the current market price. Conversely a Sell Stop Order is where you make a pending Sell Offer at a price below the market value. A StopLoss is a Stop Order. If you Buy, you will then set a StopLoss which will be a Sell Stop Order at below market value.

You will typically see Stop Orders being used in a breakout strategy.

Latency

Latency refers to the time that it takes for your trade to leave your computer and get to your broker. It is measured in milliseconds(yes 1 ms is one thousandth of a second). If my robot sends a trade request from my computer in Dubai to my broker in New York, it takes around 250ms to get there. Of course don't forget, the information that triggered the trade came from the same broker and is also 250ms old, for a total of 500ms. By contrast, my VPS is located in NYC and has a latency of 2ms. Now you might ask yourself what difference does a couple of milliseconds make. Side note : If you don't know what a VPS is,  click here to find out more about VPS

In order to appreciate the effect of latency let us examine how a trade takes place. I am sure you have all heard the phrase "while stocks last". Commonly used in conjunction with a discount offer. The price you see attracts you to the deal, you turn to your wife and get clearance to buy......you walk into the shop and the clerk tells you they are all sold out.....guess what, you will pay a higher price for the same thing because you were too slow......everyone else has bought and you have to now take whatever you can get.

The broker works in the same way. The robot will see a price and decide to execute but you are competing against my VPS......my trade is at the broker before you have even received the trigger price. I will consume the price on offer and you will have to accept the next best price.

Now you have carefully read my blog and taken the info on board......so you decide to trade off a VPS and make use of the 2ms latency. Of course now you are competing against my robot which has used Stop Orders.....once again when the trigger price is hit, my trade is right there and is executed instantly, before the trigger price has even left the broker......once again you are left with what is left. But think on the bright side, at least you are better off than the guy trading from his laptop in Dubai.

Keep in mind that Banks pay millions of dollars to shave 1 ms off their latency. Most VPS providers have a chart showing their latency to most brokers. Here is the latency list for Forex VPS :-

Forex VPS Latency

Orders Characteristics

The order types we have discussed have certain characteristics. In terms of execution, there is no difference between Market Orders and Stop Orders. A Stop Order is simply a delayed Market Order. The benefit of using the Stop Order over the Market Order is that of latency, slippage and ultimately the price that you get filled at.

Liquidity is the availability of trades. All orders affect liquidity.....they either supply it or they consume it. Limit Orders are the only orders that provide liquidity. When you look at the spread, you are looking at opposing limit orders. Take profit is technically a Limit Order. Another characteristic of a Limit order is that you will ALWAYS get your price. There will never be any slippage apart from possibly some in your favour. Don't believe me, go check your trading history. You will see that all your orders that hit TP, will have been closed at TP or better.

I actually used to trade with a broker(MB Trading) that paid me for placing Limit Orders, as opposed to me paying commission, because they considered my trade as liquidity supply.

In contrast to Limit Orders, Stop Orders and Market Orders are said to consume liquidity(remember a Stop Order is simply a delayed Market Order). There is no other way.....the only way your trade is executed is when you are used to complete another trader's Limit Order. He has been waiting for somebody to offer him a better price and that person was you. A seller of a house puts his house on the market, creating availability of property on the market. If you buy the house at his price, you remove it from the market, thereby reducing availability in the market.

Since Market & Stop orders consume liquidity, they are subject to filling at best price(remember "whilst stocks last")......that means that you are not entitled to get your price......the broker will only try and get you the best price. If someone else consumes the liquidity, you will get the next best price.

Another characteristic of orders is how the market reacts to their use. If you have a cluster of Stop Orders together, they are going to cause a run on the price(breakout). This is because when your Stop Order is filled, it removes liquidity and will cause the next available price to move in the direction of your trade. If there is a Stop Order waiting at the price that is next in line, it will be filled and again cause the price to move and so on.

Conversely, clusters of Limit Orders will act as resistance or support. If lots of people are placing buy Limit Orders, consumption will be less likely to drive the price down.

A word about spreads

I often see people referring to brokers that offer the best spreads. Please remember that spreads are only half the story. Razor sharp spreads are useless if the broker cannot back it up with Depth of Liquidity.  The spreads you see are the opposing Limit Orders on offer, and it doesn't matter what size trade is available at that price......it is still the price.

Imagine you see a Ask at 110 and Bid at 100, giving a spread of 10. The problem is there is only 1 widget available at each of these prices......but you want 3 widgets. You will get the first widget at 110, which is where the best Sell Limit Order is placed. The broker will then have to look to the next available stock, which may be 115 for the next one and 120 for the third one. Your final fill price is the cost average of the completed order (110+115+120)/3, so you were filled at 115 average which is the price you will see returned to you. 

You can easily see that the spread that was shown did not really result in the best price. This difference between the price you requested and the price you received is called slippage. You have no control over it and you are totally at the mercy of your broker. Unfortunately, there are no tables showing average slippage at various brokers, only tables showing spreads. You can only try a broker and monitor slippage.......the proof of the pudding is in the eating.