Education Of A Commodity Trader:

The Mechanics of Trading: Orders

Click on any illustration to enlarge.

All traders not on the exchange floors must initiate and exit trades by giving orders to their brokers. These orders are relayed to the floor where they are given to floor brokers for execution.

The most common and basic order is the market order. This order simply gives the amount of the commodity that the customer wants to buy or sell. The market order instructs the floor broker to initiate the transaction at the current market value. The brokers are instructed to get the best possible price, but, as a practical matter, the floor broker will take the bid price if trying to sell and take the offer price if trying to buy. Only on exceptionally large trades and only if given discretion will the floor broker actively try to seek out a better price. The market order is best used when speed is important. The market order is filled essentially on entering the pit. It can be useful for a fast-moving market where the trader needs to get in or out quickly to initiate or exit a trade. Traders may also use a market order when prices have reached a level where they wish to initiate a trade. Exhibit 3-4 gives an example of a market order.

The market order is the simplest and easiest order to enter. The customer states, for example, "Buy one December Value Line at the market." It is the basis from which all other orders flow, elaborating and setting limits on the basic market order.

A price limit order instructs the floor broker to execute the trade at the stated price or better. For example, "Buy one December Value Line at 162.00 limit" means to buy the December Value Line contract at 162.00 or better. This ensures that the client will receive a price of 162.00 or less in the purchase of the December Value Line. Traders should note that it is quite possible that the price of the commodity may hit or even move through the limit price level specified and yet not be filled on the order. Although this is not common, the price of the commodity can be slightly different on different sides of the pit. It is therefore possible that the floor broker was unable to accomplish the price level specified. The limit order is always placed under the market if it is a buy order and above the market if it is a sell order. It is usually used to initiate positions rather than exit them. It is particularly useful in trying to initiate trades in illiquid markets. A limit order is shown in Exhibit 3-5.

A first cousin of the limit order is the "fill or kill" order. This is a limit order that is sent to the pit that must be executed immediately or it is canceled. In other words, if the price is not at or below the limit at the time the order is received, the order is immediately canceled and the client notified.

A stop order is a market order when a specified price level is reached. The stop order is often confused with the limit order. The difference between a stop order and a limit order is that a stop order is placed above the market on the buy side and below the market on the sell side. Traders wishing to buy a contract could use either the limit or the stop order. If the current price were 155.00, traders would enter a limit order as "Buy one June NYSE Index at 154.90 limit" or "Buy one June NYSE Index at 155.10 stop." When the stop level is reached, the stop order becomes a market order. This means that the actual fill on the order may be significantly different from the price mentioned in the stop order. An example of a stop order is shown in Exhibit 3-6.

The most common use of limit orders is to enter the market, and the most common use of stop orders is to protect investors' positions. Investors usually seek to find the best price before entering an order. This is why they use the limit order to enter positions. On the other hand, traders already in positions do not want them to become losers, and, therefore, as the position moves against them, they use stop orders to exit a position.

A combination of the stop and the limit order is the stop limit order. With this hybrid, the stop order becomes a market order when hit, but the price to be entered at must be at the stop level or better. This is often a difficult order to execute as it means the price must stay at the stop level or become more advantageous to be filled. If the price just keeps moving through the stop level, then the order will not be filled. A stop limit order is used more for entry than for exit because of this situation.

The market if touched (MIT) order is similar to the stop order. A MIT order is executed as a market order when the price reaches the level specified in the order. For example, "Buy one March S&P 500 Index at 125.00 MIT" is a market order when the market floor's board shows a price of 125.00.

Orders may be limited by time as well as price. Unless otherwise mentioned, all orders are considered day orders; this means they are canceled at the end of the trading session if not filled. An alternative to the day order is the good till canceled (GTC) order. This is shown in Exhibit 3-7. Another term for this order is "open order." The GTC order is considered always in force until either filled or canceled or until the contract month expires. Brokerage houses are leery of GTC orders because they have often been in the unfortunate position of having the order become filled when the client has forgotten that the order is in and no longer wishes to be in the position. Most brokers will suggest that traders enter a series of day orders as this provides a constant reminder that the trader wishes to initiate a position. Brokerage houses will typically send a written notification in the mail when their clients enter GTC orders.

The time limit order is another order limited by time rather than price. This can be any type of order but is canceled when a certain time is reached during the trading session. An example is "Buy 10 June S&P 100 at 168.00 stop, noon."

Two very popular orders are the market on open (MOO) and the market on close (MOC) orders. Exhibit 3-8 shows a MOC order. These are market orders that are executed on the open or close. MOO will be executed in the first 30 to 60 seconds of trading and must be within the opening range. A MOC order will be executed in the last 30 or 60 seconds of trading and must be within the closing range. Many people believe that the opening and closing are the most significant prices of a trading session. Academic theory suggests that these are important because they represent the accumulated concepts of market participants as they adjust to overnight factors on the opening or as they try to predict what may happen overnight on the close. Many technical and mechanical trading systems use MOO and/or MOC orders. They do this because the opening and closing prices are recorded, whereas intra-day prices are often not recorded except when they are the high or low.

At most exchanges, orders initiated within 15 minutes of the opening or close are on a "not held" basis. This means that stop and limit orders are not necessarily guaranteed. A floor broker will try but will not guarantee the fills. For example, a limit order placed in the middle of the trading session must be filled at the specified price or better. If the order comes back at a price worse than specified, then either the floor broker or brokerage house will correct the problem with the customer. If the same order was placed within 15 minutes of the open or close, then the client does not have recourse to the brokerage house or floor broker and must accept the order fill as received.

Traders use the cancel order to eliminate a previous order. The two types of cancel orders are the straight cancel order and the cancel former order. The latter order is also sometimes referred to as a cancel and replace order. The straight cancel order does exactly what it saysit cancels the previous order. For example, if an order had been placed to buy the mini-Value Line contract on a stop, the trader could cancel the order by telling the broker to cancel the order. The cancel former order (or cancel and replace order) cancels the previous order but replaces it with new instructions. A canceled order is shown in Exhibit 3-9.

A relatively rare order is the combination, or contingency, order. This order specifies two orders mentioned above, or when one price level is reached in one contract, an order is placed in another contract. These are relatively rare as few exchanges take them.

The final type of order is the spread order. A spread order is an order for the purchase and sale of two different contracts. The contracts may be within the same commodity but may not be in the same month. Alternately, they could be in two separate commodities, in which case they could be within the same month. A spread order is entered in terms of the price level that one contract is over or under the other contract or simply as a market order. Stop orders used to be acceptable in combination with spread orders but are now very rare. Two examples of spread orders would be "Buy one March NYSE index and sell one June NYSE index at 35 points premium the March" and "Buy two September NYSE index and sell one September Value Line at 950 points premium the NYSE Index." We will discuss spreads more fully in another chapter. Exhibit 3-10 is an example of a spread order.

Although we have described many types of orders, not all orders are taken at all exchanges. The orders that each exchange accepts are largely determined by the floor brokers one is dealing with. For example, the Chicago Board of Trade does not accept spread stop orders but the Chicago Mercantile Exchange does. Nonetheless, it is difficult to enter a spread stop order at the Chicago Mercantile Exchange as there are few floor brokers who are willing to accept it. Contingency orders are also accepted by many exchanges but by few brokers. In the final analysis, it is the floor broker who determines what orders are accepted or not accepted. Traders should keep in contact with their brokers to alert them to changes in acceptable orders for each exchange.

Here's another site with useful information about futures orders. They include which exchanges accept which orders:
Order Entry Handbook

 

RETURN