What is an Order?

An order comprises instructions given to a broker or brokerage firm to buy or sell a security on behalf of an investor. It is the fundamental trading unit in a securities market. Orders are typically placed by phone or online via a trading platform, although there is a growing trend towards using automated trading systems and algorithms. Once an order is placed, it goes through a process of execution.

Orders can be categorized in various ways, allowing investors to impose conditions on their orders related to price and execution time. These conditions can specify a certain price level (limit) at which the order must be executed, the duration for which the order remains valid, or whether an order is triggered or canceled based on another order.

Understanding Orders

Investors use brokers to buy or sell assets by selecting a specific order type. When an investor decides to trade an asset, they initiate an order, providing the broker with detailed instructions on how to proceed.

Orders can be placed to trade various assets, including stocks, currencies, futures, commodities, options, and bonds.

Typically, exchanges trade securities through a bid/ask process. This means that for a sale to occur, a buyer must agree to the selling price, and for a purchase to occur, a seller must agree to the buyer's price. A transaction only happens when both buyer and seller agree on the price.

The bid is the highest price someone is willing to pay for an asset, and the ask is the lowest price at which someone is willing to sell. These prices constantly fluctuate because each bid and offer represents an order. As orders are fulfilled, these levels adjust. For instance, if there are bids at 25.25 and 25.26, once all orders at 25.26 are filled, the next highest bid becomes 25.25.

Understanding this bid/ask process is crucial when placing an order, as the chosen order type will affect the trade's execution price, timing, or whether the trade will be executed at all.

Order Types

In most markets, orders can be placed by both individual and institutional investors. Individuals typically trade through broker-dealers, who require them to select from various order types when executing a trade. Different order types offer investors some discretion in planning their trades.

The type of order chosen can significantly impact the trade's outcome. For instance, when attempting to buy, placing a buy limit order at a price lower than the current trading price might allow the trader to secure a better price if the asset's value decreases. However, if the limit price is set too low, the asset price may never reach it, causing the trader to miss out if the price rises instead.

Market Order

A market order directs the brokerage to execute the trade at the best available price. Market orders are generally always executed unless there is no trading liquidity.

Limit Order

A limit order specifies a price at which to buy or sell a stock. Limit orders ensure that a buyer only pays a specific price to purchase a security. These orders can remain active until they are executed, expire, or are canceled.

Limit Sell Order

A limit sell order instructs the broker to sell the asset at a price above the current market price. This order type is used for long positions to take profits when the asset price increases after purchase.

Stop Order

A stop order directs the brokerage to sell an asset if it drops to a specified price below the current market price. This can be either a market order, accepting any price when triggered, or a stop-limit order, which only executes within a specified price range after being triggered.

Buy Stop Order

A buy stop order instructs the broker to purchase an asset once it reaches a specified price above the current market price.

Day Order

A day order specifies the timeframe in which the order must be executed, requiring that it be completed within the same trading day it is placed.

GTC Order

A good-'til-canceled (GTC) order also specifies the timeframe for execution. This order remains active until it is either filled or canceled.

Immediate-or-Cancel Order

An immediate-or-cancel (IOC) order must be executed almost immediately, often within seconds. If it is not fulfilled within this brief timeframe, the order expires.

All-or-None Order

An all-or-none (AON) order requires that the entire order be filled. Partial fills are not acceptable. If the entire order cannot be filled, it is not executed at all.

Fill-or-Kill Order

A fill-or-kill (FOK) order demands immediate and complete execution. If the order cannot be entirely filled right away, it is canceled. This order combines the features of an all-or-none order and an immediate-or-cancel order.

No one order type is inherently better or worse than another; each serves a unique purpose. The appropriate order type depends on the trader's specific goals and risk tolerance.

Example of Using an Order for a Stock Trade

When buying a stock, a trader should plan both their entry and exit strategies to manage potential profits and losses. This often involves placing three orders at the beginning: one to enter the trade, a second to limit risk if the price moves unfavorably (a stop-loss order), and a third to secure profit if the price moves favorably (a profit target).

While exit orders don't need to be placed simultaneously with the entry, traders should still have a clear strategy for exiting, whether with a profit or loss, and understand which order types they will use.

For instance, assume a trader wants to buy a stock. Here is one possible setup for placing their orders to enter the trade, manage risk, and take profit.

They monitor a technical indicator for a trade signal and place a market order to buy the stock at $124.15. The order fills at $124.17, and the difference between the market order price and the fill price is called slippage.

To limit risk, they decide not to risk more than 7% on the stock, placing a sell stop order 7% below their entry price at $115.48, acting as the stop-loss.

Based on their analysis, they anticipate a 21% profit from the trade, expecting to make three times their risk. This favorable risk/reward ratio leads them to place a sell limit order 21% above their entry price at $150.25, which is their profit target.

One of these sell orders will be triggered first, closing out the trade. If the price reaches the sell limit order first, the trader secures a 21% profit.

What's the Difference Between a Limit Order and a Market Order?

A limit order specifies the maximum price at which an investor is willing to buy an asset and the minimum price at which they are willing to sell. This strategy aims to maximize profits and minimize losses. In contrast, a market order directs the broker to execute the trade at the best available price without price limitations.

Is a Batch Order the Same as a Market Order?

A batch order differs from a market order, though it comprises multiple market orders. Batch orders are placed between the close of one trading session and the start of the next. A brokerage combines several orders for the same stock into a single transaction, executed at the market's opening the following day.

Why Do Traders Place Orders?

Traders use orders to enter or exit trades at specific prices within a defined timeframe. Orders help maximize profits and limit losses and enable traders to capitalize on sudden or unexpected price movements.

The Bottom Line

An order is an instruction given to a broker to buy or sell an asset on behalf of a trader. Various order types enable investors to specify the purchase or sale price, timing of the trade, and conditions under which the trade will be executed or canceled.

Traders choose order types based on their predictions of asset movements, desired profit levels, and the speed of execution. They can place multiple order types simultaneously to protect profits and minimize the risk of loss.