Currency traders use orders to
catch market movements when they’re not in front of their screens. Remember: The forex market is open 24
hours a day. A market move is just as likely to happen while you’re asleep or
in the shower as it is while you’re watching your screen. It you’re not a
full-time trader, then you‘ve probably got a full-time job that requires your
attention when you’re at work - at least your boss hopes he has your attention.
Orders are how you can act in the market
without being there.
Experienced currency traders also
routinely use orders to:
- Implement a trade strategy from entry to exit
- Capture sharp, short-term price fluctuations
- Limit risk in volatile or uncertain markets
- Preserve trading capital from unwanted losses
- Maintain trading discipline
- Protect profits and minimize losses
We can’t stress enough’ the
importance of using orders in currency trading. Forex markets can be
notoriously volatile and difficult to predict. Using orders will help you
capitalize on short-term market movements, as well as limit the impact of any
adverse price moves. A disciplined use of orders will also help you to quantify
the risk you‘re taking and, with any luck, give you peace of mind in your
trading. Bottom line: If you don’t
use orders, you probably don‘t have a well-thought-out trading strategy and
that’s a recipe for pain.
Types of Orders
I will introduce you to all the
types of orders available in the Forex market. Bear in mind that not all order
types are available at all online brokers. So add order types to your list of
questions to ask your prospective forex broker.
Take-profit
orders
Don’t you just love that name?
There’s an old market saying that goes, “You can’t go broke taking profit.”
You’ll use take-profit orders to lock in gains when you have an open position
in the market. If you’re short USD/JPY at 117.20, your take-profit order will
be to buy back the position and be placed somewhere below that price, say at
116.80 for instance. If you’re long GBP/USD at 1.8840, your take-profit order
will be to sell the position somewhere higher, maybe 1.8875.
Partial take-profit orders are take-profit orders that only close a
portion of your open position. Let’s say you bought 200,000 EUR/USD at 1.2950
expecting it to move higher - and it does. But to take some money off the table
and lock in some gains, you decide to sell half the position (100,000 EUR/USD)
at 1.3000 and to allow the market to see how high it wants to go with the rest.
Or you can place two partial take-profit orders to close the whole position at two
different levels.
Limit
orders
Technically speaking, a
take-profit order is a type of limit order. The key difference is that
take-profit orders close or reduce open positions and limit orders open new
positions or add to existing positions in the same direction.
A limit order is any order that
triggers a trade at more favourable levels than the current market price. Think
“Buy low, sell high.” if the limit order is to buy, it must be entered at a
price below the current market price. If the limit order is to sell, it must be
placed at a price higher than the current market price.
Stop-loss
orders
Boo! Sound’s bad doesn’t it‘?
Actually, stop-loss orders are critical to trading survival. The traditional stop-loss
order does just that: it stops losses by closing out an open position that is
losing money. You’ll use stop-loss orders to limit your losses if the market
moves against your position. If you don’t, you’re leaving it up to the market,
and that’s always a dangerous proposition.
Stop-loss orders are on the other
side of the current price from take-profit orders, but in the same direction (in
terms of buying or selling). If you’re long, your stop-loss order will be to
sell, but at a lower price than the current market price. If you’re short, your
stop-loss order will be to buy, but at a higher price than the current market.
Trailing
stop-loss orders
A trailing stop is a beautiful
little tool, especially when you’ve got a winning trade going. You may have
heard that one of the keys to successful trading is to cut losing positions
quickly, and let winning positions run. A trailing stop-loss order allows you
to do just that. The idea is that when you have a winning trade on, you wait
for the market to stage a reversal and take you out, instead of trying to pick
the right level to exit on your own.
A trailing stop-loss order is a
stop-loss order that you set at a fixed number of pips from your entry rate.
The trailing stop adjusts the order rate as the market price moves, but only in
the direction of your trade. For example, if you’re long EUR/CHF at 1.5750 and
you set the trailing stop at 30 pips, the stop will initially become active at
1.5720 (15750 - 30 pips).
If the EUR,/CHF price moves
higher to 1.5760, the stop adjusts higher, pip for pip, with the price and will
then be active at 1.5730. The trailing stop will continue to adjust higher as
long as the market continues to move higher. When the market puts in a top,
your trailing stop will be 30 pips (or whatever distance you specify) below
that top, wherever it may be.
If the market ever goes down by
30 pips, as in this example, your stop will be triggered and your position
closed. So in this case, if you’re long at 1.5750 and you set a 30-pip trailing
stop, it will initially become active at 1.5720. If the market never ticks up
and goes straight down, you’ll be stopped out at 1.5720. If the price first
rises to 1.5775 and then declines by 60 points, your trailing stop will have
risen to 1.5745 (1.5775 - 30 pips)and that’s where you’ll be stopped out.
Pretty cool, huh? The only catch
is that not every online trading platform offers trailing stops. If you find a
platform you like and it doesn’t offer trailing stops, you can mimic a trailing
stop by frequently manually changing the rate on your regular stop-loss order.
But this is an imperfect solution unless you can monitor your position constantly.
One-cancels-the-other
orders
A one-cancels-the-other order
(more commonly referred to as an OCO order) is a stop-loss order paired with a take-profit order. It’s the ultimate
insurance policy for any open position. Your position will stay open until one
of the order levels is reached by the market and closes your position. When one
order level is reached and triggered, the other order automatically cancels.
Let’s say you’re short USD/JPY at
117.00. You think if it goes up beyond 117.50,
it’s going to keep going higher, so that’s where you decide to place
your stop-loss buying order. At the same time, you believe that USD/JPY has
downside potential to 116.25, so that’s where you set your take-profit buying
order. You now have two orders bracketing the market and your risk is clearly
defined.
As long as the market trades
between 116.26 and 117.49, your position will remain open. If 116.25 is reached
first, your take profit will trigger and you’ll buy back at a profit. lf 117.50
is hit first, then your position is stopped out at a loss.
OCO orders are highly recommended
for every open position.
Contingent
orders
A contingent order is a fancy
term for combining several types of
orders to create a complete currency trade strategy. You'll use contingent
orders to put on a trade while you’re asleep, or otherwise indisposed, knowing
that you’re contingent order has got all the bases covered and your risks are
defined. Contingent orders are also referred to as if/then orders. If/then orders require the if order to be done first, and
then the second part of the order becomes active, so they're sometimes called
If done/then orders.
Let’s look at a trade idea and
see how a contingent order works. Say NZD/USD has been trading in a range
between 0.6700 and 0.6800 and is currently sitting in the middle at 0.6750/54.
You think it’s going to go higher, but you don’t want to jump in at the middle
of the range and risk watching it go down before it goes up. So you use a
contingent order to implement your strategy, even if you’re not watching the
market.
Because you’re ultimately looking
to buy on a dip toward 0.6700 to get long, you would place an if/then limit
order to buy at 0.6710, the if part
of the order. The contingent, or then,
part of the order only becomes active if the if part is triggered and you enter a position.
The then part consists of either a stop-loss order or a take-profit
order, or both in the form of an OCO order.
Continuing with this example,
your contingent order may be to place a stop-loss order below 0.6700, in case
the range breaks and you’re wrong. So you may place your stop-loss order at
0.6690 to sell what you bought in the if
part. This type of contingent order is called an if/then stop loss. You may opt for only an if/then stop-loss order if you want to limit your downside risk,
but let your upside gain run.
If you think the upside is
limited to the range highs at 0.6800, you may want to add a contingent
take-profit order at 0.6790 to sell what you bought at 0.6710, in addition to
your stop-loss order. Now if your position is opened at 0.6710, you have an OCO
order to stop sell at 0.6690 or take profit at 0.6790. Now you have a complete
trade strategy with defined risk parameters.
If the market continues to trade
in the range, it may drop from the level you saw (05750/55) before you went to
bed. If it hits 0.6710, then your long position is established and your OCO
orders are activated. If the range holds and the price moves back up to the
range highs, your take profit at 0.6790 might be triggered. If the range fails
to hold, your stop-loss order will limit your losses and close out your trade
for you.
Be careful about using if/then
orders with only a contingent take-profit order. Not using a stop loss to
protect your downside is always very risky. At the minimum, always use an
if/then stop loss to limit your risks.
If you use an if/then OCO order
and the market behaves as you expect, you could awaken to find that you bought
at 0.6710 and took profit (sold) at 0.6790, all while you slumbered through the
night. Or you could awaken to find that your if order to buy was done, but the
market has not yet hit either your stop-loss or take-profit levels. But at least
your open position is protected by the activated OCO order. Worst-case scenario
in this example: You wake up and find that your if limit order was filled and your stop was triggered on a break
through the bottom of the range, giving you a loss. The key is that you effectively
managed your risk.
Spreads
and orders in online currency trading
Now that we’ve covered the
different order types, I think it’s important for you to be aware of how online
trading platforms typically handle traders‘orders. We spent some time earlier
in my previous post discussing forex market spreads and the role of the
market-maker. There was a good reason for that: Online forex brokers accept
your orders according to their trading policies, which are spelled out in
detail in the fine print in the contract you’ll have to sign to open up an
online trading account. Make sure you read that section to be absolutely
certain what your broker’s order execution policies are.
The key feature of most brokers
order policies is that your orders will be executed based on the price spread of the trading platform.
That means that your limit order to buy will only be filled if the trading
platform’s offer price reaches your buy rate. A limit order to sell will only
be triggered if the trading platform’s bid price reaches your sell rate.
In practical terms, let’s say you
have an order to buy EUR/USD at 1.2855 and the broker’s EUR/USD spread is 3
pips. Your buy order will only be filled if the platform’s price deals
1.2852/55. If the lowest price is 1.2853/56, no cigar, because the broker’s
lowest offer of 56 never reached your buying rate of 55. The same thing happens
with limit orders to sell. ;
Stop-loss execution policies are
slightly different than in equity trading because most online forex brokers
guarantee that your stop-loss order will be executed at the order rate. To be
able to guarantee that, brokers rely on the spread.
- Stop-loss orders to sell are triggered if the
broker’s bid price reaches your
stop-loss order rate. In concrete terms, if your stop-loss order to sell
is at 1.2820 and the broker's lowest price quote is 1.2820,/23, your stop
will be filled at 1.2820.
- Stop-loss orders to buy are triggered if the platform’s
offer price reaches your
stop-loss rate. If your stop order to buy is at 1.2875 and the broker’s
high quote is 1.2872/75, your stop will be filled at 1.2875.
The benefit of this practice is
that some firms will guarantee against slippage on your stop-loss orders in
normal trading conditions. (Rarely, if ever, will a broker guarantee stop
losses around the release of economic reports.) The downside is that your order
will likely be triggered earlier than stop-loss orders in other markets, so
you’ll need to add in some extra cushion when placing them on your forex
platform.
