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A Closer Look at CFD Trade Orders
In this edition, we give go into details of the various types of CFD trade order available.
When CFDs can not be traded on live tradable prices, they can be traded by placing orders. Trading by order can be almost as fast and direct as trading on live prices, and can be done by exchange order book participation.
Use of Orders
Trading on live tradable prices is typically used for entering and exiting the market fast when you feel the conditions are right. Trade orders allow you to make a more strategic approach to trading and to plan your moves up front. Taking a more disciplined approach to taking a position, you would typically use:
- An entry order to trade when (if) the market reaches a specific price.
- A take profit order to close the position when the market price reaches a level you expect it to reach.
- A stop loss position to the position in case the market moves in the wrong direction. Note: This is always highly recommended, serious traders should always protect their positions and limit their losses in case of adverse market moves.
There are three basic order types to help you do this:
Market Orders
Market Orders trade to trade as soon as possible at any price obtainable on the market – use these only when you want to be filled as fast as possible and are not critical about the price you will be filled at.
Market Orders are typically used when direct trading on live tradable prices is not available, for example when your CFD provider is not the market maker for the CFD, the market is closed or for large trade volumes.
Limit Orders
Limit Orders are used to trade when the price hits or breaches a level you define (a sufficient quantity must of course be available for the trade to be executed). Limit orders are usually placed below the market for buy orders (so you buy when the price falls to a level you specify) and above the current market price for sell orders.
Limit orders to buy can also placed above the market which will execute for the volume of stocks that exist at the market price or better. This guarantees the price you will pay will never be more than the limit price you specify.
Limit orders are typically used to:
- Enter the market when the market falls/rises (don't forget with CFDs you can short a stock as easily as going long) to an entry level you specify.
- Close a position to take profit, when the price rises/falls to the level you predict.
Limit orders do not guarantee that your position will be filled at all if the price never reaches the price you specify. And if the price does move as anticipated, there is no guarantee that the total quanitiy of your order will be filled, but Limit Orders do guarantee the price you specify or better.
Stop Orders
Stop orders are used in a similar way to limit orders to trade when the price hits a defined level, but are used to trade against the market. So stop orders are placed above the market for buy orders and below the current market price for sell orders.
Important: Unlike limit orders, stop orders are executed when the price hits or breaches a level but there is little or no guarantee that you will be filled at that price. When the price hits or breaches your specified price, Stop Orders become Market Orders and are then filled at whatever price is available in the market. So if only a few shares are available at the stop price you specify, the rest of your order may well be filled at another level. This uncertainty is sadly unavoidable but none the less bad news when you are trying to protect yourself against losses.
- The most common use of stop orders is to close positions to limit losses if the market heads in the wrong direction from that you predicted. For example if you are holding a short position, you would place a stop order to buy at a price above your entry price to close your position and limit your losses.
- Another use of stop orders is to wait for a market turn-around. So you might place a stop order to open a long (buy) position if the market is trending in the right direction and the price moves above the current price.
Linked Orders
To complete this introduction to basic trading mechanisms, we need to talk about linked orders.
- A limit order to open the position when the market hits the right price
- A limit order to close the position again to take profit if the market behaves as you anticipate
- A stop order to close the position to limit losses if things go wrong
If Done Orders
Take profit and stop loss orders should not be placed at the same time as the entry order as they might be
executed before it. You would then be in an unpredictable position. They should be placed if, and only if,
the entry order executes. We can do this if we link the take-profit and stop-loss orders to the entry order
in an If Done arrangement.
One Cancels the Other (OCO) Orders
Furthermore, if the take profit and stop loss orders are active in the market, when one of them executes, the
other will be left floating around and could execute a spurious trade. To prevent this, these two orders
need to be linked together in another relationship called One Cancels the Other, often called 'OCO' for short.
In this arrangement, as soon as one of the orders executes, the other order will be removed.
3-Way Orders
Frequently you want to place all 3 orders together; an entry order to open the position linked to 2 orders
which are placed to close the position (either to take profits or limit losses) which themselves are linked
as OCO orders. This is what we call a 3-way or contingent order.