For active forex traders, properly locating orders is a key part of conducting day-to-day business. Understanding order functionality and how different types impact trade execution is critical to interacting within the market competently. If not, untimely mistakes can lead to lost opportunity, or worse, lost capital.
On the buy-side of the equation, there are two order types that market participants need to be familiar with: buy limits and buy stops. No matter if one is opening a new forex position, aligning profit targets, or positioning stop losses, these two order types are vital to entering and exiting the market efficiently.
What Is A 'Buy Limit' Order?
A 'buy limit' order is a buy order that is filled at a prespecified price or better. Buy limit orders are classified as "pending," as they rest at market below current price until executed. Upon price action reaching the buy limit's designated point, the order is then filled. Buy limit orders may be used to enter the market in a "long" or "bullish" fashion and as profit targets for short positions.
To illustrate how a buy limit order may be used for market entry, assume that Trader A has a bullish bias toward the EUR/USD. Rates are trending upward near intermediate-term highs above 1.2075. Trader A is hopeful that if a price retracement occurs, bidders will enter the market in mass just above the 1.2000 psychological barrier. In an attempt to join the uptrend at a beneficial price, Trader A uses buy limit orders to enter the long-side of the market:
- A buy limit order is placed at 1.2009.
- If price hits 1.2009, the order will be filled at 1.2009 or better.
- Upon the buy limit being filled at 1.2009, a new long position becomes active.
It's important to remember that buy limit orders are placed below price. Accordingly, can be used as profit targets for bearish positions. As an example, assume Trader A is bearish toward the USD/CHF beneath 0.9300. Buy limits may be used as profit targets accordingly:
- Trader A opens a short position from 0.9299. This may be done in several ways, including the execution of a sell market order, a sell stop or a sell limit order (depending upon the location of price).
- For a short position profit target, the buy limit order is placed below price. Let's say that Trader A is aiming for a 25 pip gain. So, the buy limit is placed at 0.9274. If the USD/CHF falls to this level, the order will be filled, closing out the position for a 25 pip gain.
What Is A 'Buy Stop' Order?
A buy stop order combines the functionalities of a buy order and a stop-market order. Similar to buy limits, buy stops are pending orders, meaning that they rest at market until filled. However, buy stops reside above current price and are filled at the best available price when elected. In the live forex, buy stops may be used to enter the market in a bullish fashion or act as stop losses for open short positions.
Like buy limits, buy stops may also be used to open new long positions in the market. However, this is done in a much different way, as the buy stop order resides above current price action. Instead of waiting for a retracement, the buy stop furnishes the trader with an ability to enter the market with price action. This functionality is especially useful for momentum or breakout trading strategies.
To illustrate, assume that Trader A is once again bullish on the EUR/USD. The pair is trading in a prolonged consolidation pattern near 1.1990. Trader A uses a buy stop order to play a breakout above 1.2000:
- A buy stop order is placed at 1.2001.
- If the EUR/USD trades 1.2001, the buy stop order is filled at the best available price.
- A new long position is now open in the EUR/USD.
Stop loss orders are a vital part of risk management and can save the forex trader from realising catastrophic loss. Buy stops are placed above price action, thus limiting the liability of active bearish (short) positions. Functionally, buy stops are resting market orders; once elected, they provide an immediate exit from the market at the best available price.
To illustrate how a buy stop order works, let's say that Trader A has decided to short the EUR/USD from 1.1999. Further, Trader A has decided to implement a buy limit profit target at 1.1974 and adhere to a 1:1 risk vs reward ratio. The buy stop is placed accordingly:
- Trader A places the buy stop order at 1.2024. This location is 25 pips from entry and adheres to the trade's 1:1 risk vs reward parameter.
- If the EUR/USD trades 1.2024, the buy stop order liquidates the short position at the best available price.
- Upon 1.2024 being hit, Trader A takes a 25 pip loss plus or minus any realised slippage.
Although buy limit and buy stop orders both deal with the long-side of the forex market, they are unique devices. Below are the key differences:
- Buy limit orders are located below current price; stop orders are located above current price.
- Buy limit orders are filled at a designated price or better; buy stop orders are filled at the best available price.
- Buy limit orders are designed for precision; buy stop orders are intended to enter or exit the market immediately upon being elected. Accordingly, buy stop orders are prone to slippage, whereas buy limit orders are not.
In the live forex market, it's up to the trader to decide whether buy limits or buy stops are best-suited for the task at hand. Ultimately, the ideal order type will depend upon the trade's market position (long/short) and the strategy being implemented.
Please note that all illustrations are only shown for the purpose of a technical demonstration and should not in any way be construed as recommending any type of trading strategy and they do not constitute any form of investment advice.
FXCM Research Team
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