What Is an Order in Trading?
In the context of CFD (Contract for Difference) trading, an order is a fundamental component of market operations. An order represents a trader's intent to buy or sell a specific asset. Essentially, it is an instruction given to a third party to execute a trade on behalf of the trader. These orders can range from simple to highly complex, designed to fulfil various trading strategies and goals.
Orders are the lifeblood of investment activities. They serve as the primary means of communication between buyers and sellers, ensuring the smooth functioning of financial exchanges. In today's fast-paced markets, the sophistication of order systems is crucial. Automated systems now handle the bulk of order processing, enabling rapid execution and minimising human error.
Financial markets process millions of orders daily. These orders can trigger other orders, creating a chain reaction influenced by price movements and market conditions. This interconnectedness extends globally, reflecting the international nature of modern trading.
Given the volume and complexity of orders, it's critical that the systems managing these transactions are robust and secure. Exchanges, banks, and brokerages must ensure the integrity and reliability of their order-clearing mechanisms to prevent disruptions. The stability of these systems is so crucial that it's a common theme in financial thrillers, where a breakdown in the order-clearing process often leads to dramatic consequences.
Understanding the various types of orders and their roles in the market is crucial as you continue your foray into the volatile arena of CFD trading.
Types of Trading Orders
As a budding trader, you may already be familiar with several types of orders commonly used in the markets. When it comes to CFDs, understanding different order types is crucial for both individual and institutional investors. Orders are the instructions traders give to their brokers to execute trades, and the type of order placed can significantly impact the outcome of a trade. Here, we delve into the most commonly used order types and their implications.
Market Order
A market order instructs the broker to execute the trade at a currently available price. This type of order is almost always executed immediately, provided there is sufficient liquidity in the market. Market orders are ideal for traders looking to enter or exit positions quickly without waiting for a specific price point. However, the actual execution price may vary, especially in volatile markets, as it reflects the current market conditions at the time of the trade.
Stop Order
A stop order triggers a trade when an asset reaches a specified price, known as the stop price which is usually less favourable than the current price.. Once the stop price is reached, a stop-market order becomes a market order, and is executed at a currently available price. Stop orders can also be used to close a position, either to limit losses (Stop Loss order) or lock in profits by automatically selling an asset if its price drops to a certain level after it moved in your favour (Trailing Stop Order).
Limit Order
A limit order sets a specific price at which a trader is willing to buy or sell an asset. For a buy limit order, the trade will only be executed at the limit price or lower, while a sell limit order will be executed at the limit price or higher. This type of order gives traders more control over the price at which their trades are executed, but there is a risk that the order may not be filled if the price specified by the trader is not reached. Limit orders, similarly to stop orders can remain open until they are executed, expire, or are cancelled.
Day Order and Good-'Til-Cancelled Order
Day orders and good-'til-cancelled (GTC) orders specify the timeframe in which the trade must be executed. A day order must be executed within the same trading day it is placed, expiring at the end of the day if not filled. A GTC order remains active until it is filled or cancelled by the trader, providing flexibility for those not concerned with immediate execution.
Immediate-or-Cancel, All-or-None, and Fill-or-Kill Orders
These specialised orders cater to specific execution requirements. An immediate-or-cancel (IOC) order demands immediate execution of all or part of the order, with any unfilled portion cancelled instantly. An all-or-none (AON) order stipulates that the entire order must be filled, otherwise, it remains unexecuted. A fill-or-kill (FOK) order combines the immediacy of an IOC order with the completeness of an AON order, requiring the entire order to be filled immediately or not at all.
Understanding these various order types allows traders to better understand both the CFD market, as well as the functioning of the global financial markets as a whole.
Example of Using an Order
Let’s take a look at a specific example of how one specific time of stop order, a trailing stop order, could look in practise. The purpose of this type of order is to keep a position open when the underlying tool’s price movements are favourable to the trader, but to close if the market momentum shifts in the opposite direction by a certain preset amount. This type of order can be particularly useful in CFD trading for managing risk and securing gains.
For a buy position, a trailing stop order protects profit as the instrument's price rises and limits losses when the price falls. Conversely, for a sell position, it protects profit when the instrument's price falls and limits losses when the price rises. While this feature is free of charge, it's important to note that the exact exit price is not guaranteed.
Consider this example: You open a buy position on Microsoft (MSFT) CFDs at a rate of $100 per share, where each point represents a price movement of $1. You set a trailing stop order at 10 points. Initially, this places your stop loss at $90. As the price of Microsoft shares increases to $120, the trailing stop adjusts the stop loss to $110. If the price then drops to $110, the position will be automatically closed, thus securing your profit.
This strategy helps to lock in gains as the market moves in your favour while limiting potential losses if the market turns against you.
What Is an Order Execution?
Order execution in CFD trading refers to the process of completing a buy or sell order. Execution occurs when an order is filled, not when it is placed. Once an investor submits a trade, it is sent to a broker, who determines the optimal way to execute it.
Order execution involves fulfilling a buy or sell order in the market according to the conditions specified by the client. In today’s world, order execution may be performed either manually or electronically. Brokers are legally obligated to seek the best possible execution for their clients' trades, a requirement often enforced by regulatory bodies.
The advent of online brokers has significantly reduced the cost of executing trades. Some brokers offer commission rebates to clients who execute a certain number of trades or meet a specific dollar value of trades per month. This cost efficiency is particularly vital for short-term traders, who need to keep execution costs as low as possible to maintain profitability.
Market orders, or orders that can quickly convert to market orders, have a high likelihood of being executed at the desired price. However, large orders that are divided into smaller segments may face challenges in achieving the best possible price, introducing execution risk. This risk stems from the delay between placing an order and its final settlement, which can affect the overall cost and efficiency of the trade.
How Are Orders Executed?
Order execution can take place via various methods on the financial markets, depending on what is being traded and the various market actors involved on all sides of the trade. One traditional method is sending the order to the floor, where a human trader processes the transaction. This can be time-consuming as the floor broker needs to receive and fill the order. Alternatively, orders may be directed to a market maker, especially on exchanges like Nasdaq, where market makers are responsible for providing liquidity. The investor's broker might choose to send the trade to one of these market makers for execution.
A more efficient method involves Electronic Communications Networks (ECNs), where computer systems electronically match buy and sell orders. This process is faster and reduces the reliance on human intermediaries. Additionally, brokers may choose to execute orders in-house if they hold an inventory of the relevant stock. This practice, known as internalisation or internal crossing, allows brokers to match client orders against their own holdings, often speeding up the execution process.
Understanding these different execution methods helps traders grasp how their orders are processed, whether through traditional floor trading, market makers, ECNs, or internalisation. Each method has its own advantages and can impact the speed and efficiency of the trade.
When trading CFDs, orders can be placed and executed through the online CFD platforms.
Order Execution Example
When trading CFDs, a trader should consider how to enter and exit a position for both profit and loss. This means potentially placing three types of orders at the outset: one to enter the trade, a second to control risk if the price moves unfavourably (a stop-loss order), and a third to take profit if the price moves as expected (a profit target order).
Consider a trader planning to open a buy position on an Amazon (AMZN) share CFD. The trader monitors technical indicators and decides to place a market order to buy the CFD at $100. The order is executed at $100.50, with the difference between the intended price and the executed price known as slippage.
To manage risk, the trader decides not to risk more than 5% of their position. They place a stop-loss order 5% below their entry price at $95. This order protects against significant losses if the market moves against their position. Simultaneously, based on their analysis, the trader expects a 15% profit from the trade. They place a take-profit order 15% above their entry price at $115. This establishes a favourable risk/reward ratio, aiming to earn three times the potential loss.
One of these orders will be triggered first, closing out the trade. If the price reaches the take-profit level first, the trader secures a 15% profit. If the stop-loss level is hit first, the position is closed to limit the loss to 5%. While the risk of significant financial losses is always present when trading CFDs, properly planning your strategy is important before entering the trading arena.
How Are Orders Priced?
In traditional trading, the pricing and execution of orders depend on various factors, whether the asset is traded on an exchange or over-the-counter (OTC). For exchange-traded assets like shares, brokers access the exchange's order book, which lists current buy and sell orders, helping determine where the order should be placed. Besides primary exchanges such as the London Stock Exchange or New York Stock Exchange, Multilateral Trading Facilities (MTFs) also quote prices. MTFs can sometimes offer better prices, although not all brokers have access to them. Prices from primary exchanges and MTFs are publicly visible, known as lit books. Additionally, dark liquidity pools, available to some brokers, hide the details of trades and are typically used by institutional investors.
In OTC markets and CFD trading, like forex, CFD prices are sourced from a network of global banks and liquidity providers. One crucial factor affecting CFD order execution is slippage, which occurs when prices change rapidly between the time you place an order and when it is executed. Market orders are filled at the best available price, which can be worse than expected during volatile conditions, such as after significant news events or earnings reports. This is particularly relevant for stop-loss orders, which might not be filled at the set level during fast-moving markets.
To mitigate the risk of slippage, you can use a guaranteed stop in CFD trading, ensuring your order is filled at the set level. This provides certainty at the cost of a fee, often through a wider spread. This tool can be especially useful in volatile markets, providing an absolute limit on potential losses.
In summary, CFD prices are sourced from market participants such as liquidity and feed providers. Slippage can affect execution prices in fast-moving markets, but using a guaranteed stop can cap your losses at a set level, providing additional security for a fee.
Conclusion
To sum it all up, orders are the backbone of CFD trading, facilitating the buying and selling of assets in financial markets. From market orders executed instantly at current prices to complex stop and limit orders that manage risk and optimise profits, these instructions are essential tools for traders. As financial markets evolve, automated systems ensure rapid execution and minimise errors. Understanding and effectively using these order types are critical for navigating the risky and dynamic landscape of CFD trading.
FAQs
What is slippage?
Slippage is the discrepancy observed when the expected price of a trade and its actual value at the time of execution differ.
What are guaranteed stops?
Guaranteed stops are a risk management tool in CFD trading that ensures an order is executed at a specific price level, protecting traders from potential slippage.
What is the difference between a limit order and a market order?
A limit order specifies the maximum price a buyer will pay or the minimum price a seller will accept, while a market order is executed immediately at the best available price.
Why do traders use orders?
Traders use orders to manage risk, secure profits, and execute trades according to their investment strategies in financial markets.
What is a GTC order?
A Good-'Til-Cancelled (GTC) order remains active until it is filled or manually cancelled by the trader, providing flexibility beyond the current trading day.
