Q&A
Inside The Futures World
Want to find out how the futures markets really work? DeCarley Trading senior
analyst and broker Carley Garner responds to your questions about today’s
futures markets. To submit a question, post your question at https://Message-Boards.Traders.com.
Answers will be posted there, and selected questions will appear in a future
issue of S&C. Visit Garner at www.DeCarleyTrading.com.
Her books Currency Trading In The Forex And Futures
Markets; Commodity Options; and A Trader’s
First Book On Commodities, are available from FT
Press.
LIMITS TO LIMIT ORDERS
When is it appropriate to use a limit order to enter a market, and when should they be avoided?
As a reminder, a limit order is one in which execution is permissible only if it can be done at a price named by the trader, or at a better price. You might hear this order type referred to as an “or better” order.
Most traders are probably familiar with order types — specifically, the difference between a limit order and a stop order. Yet many of them use various order types to their detriment rather than their advantage. For instance, they may miss trades because of unfilled limit orders while attempting to save a measly $12.50, or buying a futures contract on a stop at a price that ends up being the high of the move.
Clearly, what is a better price for buyers is not for sellers. A buyer would be better off with a lower price (cheap), and a seller would be better off with a higher price (expensive). This is like anything else in business, or life for that matter, so if you look at things logically it will sink in.
For example, a store owner marks a price on an item because he would like customers to pay that amount. It would be rare for a customer to be willing to pay more than the listed price, and it is no different in the financial markets. Limit orders are seldom filled at a better price, but the trader is guaranteed that it will at least be filled at the noted price.
On the contrary: some buyers enter retail stores with a price point in mind that they are unwilling to negotiate about. They are looking to purchase an item at a specific price or less; otherwise, they will simply not buy. This is identical to the process of buying a futures contract on a limit.
For most traders participating in liquid markets, using a limit order to save a single tick on the entry or exit — as opposed to attempting to buy or sell at a better price — is inefficient.Limit orders are most useful to traders looking to buy at a much lower level than the market price, or sell at a much higher price. Traders should use limit orders for profit targets, or entry prices if they are looking for the market to travel a significant distance from the current price before they want the order to be filled. After all, it is nearly impossible to monitor the market 24 hours per day, and most futures contracts trade nearly around the clock. Having an order out there means you have a chance of getting the desired fill price on a quick spike overnight, which wouldn’t be possible otherwise.
However, for most traders participating in liquid markets, using a limit order to save a single tick on the entry or exit price — as opposed to attempting to buy or sell at a better price — is inefficient. Unless your strategy is to scalp a few pips at a time with a large quantity of contracts, getting greedy with entry and exit price probably won’t pay off. If a trader wants to be long or short a market, saving a pip on the way probably won’t have a profound impact on the overall outcome, but missing the trade altogether might!
For traders venturing into less liquid futures markets (think lumber and rough rice), limit orders are a must. In such cases, limit orders are necessary to mitigate the impact of wide spreads between bid and ask prices. This is also true for option traders, who should split the difference between the bid and ask prices when placing an order.
In contrast to nickel-and-diming a futures order, options are priced to lose, and therefore splitting the bid is simply a method of survival. Some option markets see a difference in bid and ask prices to the tune of hundreds of dollars; paying the spread directly increases transaction costs and reduces profit potential.
On a side note, I’m not a fan of using stop orders as a means of risk management or trade entry simply because they defy the logic of buying low and selling high. A stop order is the opposite of a limit order in that it is triggered if the market moves against the trader. That is the equivalent of window shopping for a week and only deciding to make a purchase once the price of the items you are interested in has risen. This doesn’t make financial sense, and the same logic could be applied to the markets.