Understanding Types of Trading Orders

What is an Order?

It is an instruction given electronically to broker/exchange that you are interested to buy/sell underlying at a specific price. A single order can be a sell order or a buy ordr, which can be used either to enter or to exit a trade. If a buy order is used to enter a trade, then only a sell order will be used to exit it.

So now we can understand what is Trade?

In simple terms when orders are completed or executed it is called Trade i.e. when a buy order matches a sell order or vice versa. For example Joe wants to buy a good at Rs 50 and Bob wants to sell the same good at Rs 50. So, this buy and sell order gets matched and is said that trade has been done.

Let’s see what are the main order types and how they can be used:

Limit Order

When you know upfront at what price you want to buy/sell underlying, it is Limit Order. It has 2 components.

a) Limit Price -

It is the price at which you want to buy/sell underlying.

b) Transaction Type (Buy/Sell) -

It is what type of transaction you want to perform.

How it works

For example, if Joe place a buy limit order of Rs 100.05 (this becomes the limit price), the order only gets executed at Rs 100.05 or better (in this case a good price is below Rs 100.05).

Now if Bob is willing to sell at Rs 100.05 then the order gets complete and will be executed.

Thus, Limit order is carried out at a price of your choice.

Market Order

When you are very desperate to buy/sell something, you can use market order. Market order is placed at market price. It has 1 component.

a) Transaction Type -

It is what type of transaction you want to perform.

How it works

For example, Joe placed a market order when the price was Rs 100 but this can be the case that other orders gets executed first at this price and Joe’s order gets completed at Rs 102 only.

So, this says that market orders always carry a risk with them of executing at a slight different price.

Stop Order

When you are not sure about the movement of market and want to protect your existing position, you can use Stop order. It has 3 components.

a) Trigger Price -

It is the price beyond which you want to keep a limit.

b) Price -

It is the price at which you want to exit your current position after trigger price is hit.

c) Transaction Type -

It is what type of transaction you want to perform.

How it works

For example, Market price is Rs 200, Joe wants to trade above Rs 202 (trigger price), so he keeps the price at Rs 204 so as market hits at Rs 204 or beyond his order will be executed. The same if wants to trade below Rs 198 (trigger price), so he keeps the price as Rs 196 so as market hits at Rs 196 or below his order will be executed.

Thus, this clearly shows that when a buy order is placed, stop price should be kept beyond the current price and when a sell order is placed, stop price should be kept below the current price.

I hope this blog will be useful in understanding the trading orders.