In forex trading, there are many types of orders that traders use to enter and exit the market. Among the most popular are stop, limit and market orders. Each offers unique functionality and a collection of strategic uses. No matter what the trader may be tasked with, it's important to understand how these three order types work and how to maximise their efficiency in live market conditions.
The Three Primary Forex Order Types: Market, Stop And Limit
At any given time, active forex traders are faced with one basic question: Should I buy or sell? Regardless of the answer, buying and selling must be carried out in an efficient manner to open new trades or close existing positions. To do so, the following order types are commonly used:
1. Market Order
Traders use a "market" or "at market" order to enter or exit the market quickly. Market orders are sent by the trader to market where they are near-instantly filled at the best available price. Although this type of functionality is ideal when speed is of the utmost concern, it can lead to increased slippage.
2. Limit Order
A limit order is used to enter or exit the market with precision. Limit orders are placed in the queue at the market, where they rest until price hits the predetermined level. When this takes place, the limit order is filled at the specified price or better. Limit orders are ideal for traders who require precision in their strategies. However, if liquidity is lagging, limit orders can be filled in an untimely fashion or skipped altogether; execution is not guaranteed.
3. Stop Order
A "stop" or "stop loss" order is used by traders to protect an open position in the market. Stops are placed at predetermined price points contrary to price action (above short positions and below longs). When the price hits the specified price level, the stop order functions as a market order. Also, it is rapidly filled at the best available price.
What Is A Buy Stop Order In Forex?
So, what exactly is a "buy stop" order in forex? Essentially, a buy stop is the combination of a "buy" order and a "stop loss" order. The buy stop rests in the market's queue above the current price until it is reached. At that point, it assumes the functionality of a market order and is instantaneously filled at the best available price.
The buy stop order may be utilised in two ways: as a stop loss for short positions or within the context of a breakout trading strategy.
Stop Loss Functionality
As a stop loss, the buy stop order's job is to protect the liability of an unfortunate short trade. Remember, it is placed above market entry and assures an immediate exit from the market. In this way, the trader is able to fully account for risk exposure and mitigate the chances of suffering catastrophic loss.
To illustrate how the buy stop works as a stop loss, assume that Erin is interested in shorting the USD/CAD. After doing some research, she decides that selling 1 standard lot of USD/CAD from 1.2400 is a solid bearish trade. When coupled with an initial stop out point of 1.2450 and a 1:1 risk vs reward management plan, Erin executes the trade as follows:
- Upon the USD/CAD reaching 1.2400, Erin sends a sell market order to the exchange via a forex platform. The order is filled immediately at the best available price, which happens to be 1.2402 (+2 pips slippage).
- Shortly after the trade goes live, she places a buy stop order at 1.2450. The location of the buy stop limits the short trade's liability to 48 pips.
- In adherence to the 1:1 risk vs reward trade management plan, a profit target is set at 1.2354. This order is a buy limit order that reflects the 48 pip initial risk profile.
In this case, Erin has used the buy stop order to manage risk in the open market. If USD/CAD rates rise unexpectedly from the 1.2400 area, the trade's maximum liability is limited to 48 pips.
A breakout trading strategy is one that aims to profit from the momentum of price action from a specific point. Accordingly, a bullish breakout trade is one taken in the hopes that price will rise from a predetermined level. A bullish breakout is executed with the direction of price, thus the buy stop order's functionality may be used to secure market entry.
In this case, let's say that Erin favours a GBP/USD bullish breakout above the key psychological barrier of 1.4000. Once again, she views a 1:1 risk vs reward ratio with a profit expectation of 50 pips to be a viable trading plan. To execute the trade, the following steps are taken:
- Erin places a buy stop order at 1.4000. The buy stop will rest at market until the current price rallies to 1.4000.
- Upon being elected, the buy stop order is filled at the best available price. In this instance, her order is filled at 1.4001 (-1 slippage).
- Once the long position is opened, a profit target (sell limit) order is placed at 1.4051. Also a stop loss order (sell stop) is placed at 1.3951. Erin may do this manually or utilise automated platform features such as bracket or OCO orders.
As a market entry device, the buy stop order has several advantages. First, it is able to rest at market above the current price. Second, the buy stop offers near-instant market entry. However, the impact of slippage may be significant as heavy participation and volatility can skew the order's fill price positively or negatively.
The buy stop order is a great tool for managing short-side risk or gaining market entry in bullish breakout strategies. Although its functionality isn't designed for precision, the buy stop does furnish the trader with an ability to enter or exit forex rapidly. If speed is an important strategic consideration, then the buy stop is ideal for opening bullish positions as well as protecting bearish positions in the market.