Market order. The easiest order to place is the market order.
It is simply an instruction to buy or sell at whatever price is being asked or bid
in the pit when the order arrives there. The floor broker will execute such an
order at the best possible price immediately upon receiving it. In an active
market, a market order is relatively safe and is quite commonly used. In a less
active market, however, this order should be used only when it is vital to have
the trade filled immediately because the price at which the trade is completed
can end up being much higher or lower than the trader originally intended.
If, for example, the
order is to buy at the market, but there are no price offers in the pit that
are close to the last trade, the floor broker will bid higher and higher until
the order is filled. The price fill received by the trader may then be quite
different from the expected price.
Market-not-held
order. This order can also be
called DRT (disregard tape). It is an instruction to the floor broker to use
his or her own discretion in filling the order, so as to obtain the best price.
Generally used with large orders in a thin market, the DRT or not held
stipulation allows the broker to work the order rather than simply dumping it
into the pit and causing a large price movement.
Market-on-close
(MOC) order. A market-on-close
order is an instruction to the floor broker to execute the order during the
last minute of trading at the end of the trading day. In an active market, such
an order can result in a good fill, but it is not uncommon for a MOC order to
be filled several ticks away from the posted closing price.
Market-on-the-open
order. This is an instruction to
fill the order at the market price immediately on the opening. The order, of
course, goes into the floor broker before the opening bell. Many traders feel
that the opening is not a good reflection of market activity and so tend to
avoid such orders.
Market-if-touched
(MIT) order. A market-if-touched
order is an instruction to execute the order at the market, but only if a
particular price is hit. For example, if the order is to buy soybeans at $6.25
MIT, the order will be activated only after $6.25 is actually asked. Then, the
broker will attempt to get the best price but at the market, which means the
actual fill could be at a price quite higher than $6.25, depending on the
market.
The MIT order is
always placed above the market if it is a buy order. This is only reasonable. A
trader wants to sell for a higher price than is being bid or buy at a lower
price than is being asked. That is only reasonable. A trader wants to sell for
a higher price than is being bid or buy at a lower price than is being asked.
That is the purpose of the MIT order. Remember, though, that the MIT order does
not guarantee that the trade will be filled at the designated price. Once the prices
hit, an MIT becomes a market order, and therefore it might be filled at a
price, particularly in a thin market.
Limit order, or
price order. If a trade wishes
to enter the market at a particular price, as with the MIT enter the market at
a particular price, as with the MIT order, but will not accept a price that is
worse then designated price, then he or she must use a limit order. This tells
the broker to fill the order at that price or better. If the order is to buy
soybeans at $6.25, the broker must fill the order at $6.25 or lower. Conversely,
if the order is to sell soybeans at $6.25, the broker must sell at $6.25 or
higher.
When placing a limit order,
the trader does not need to use the word “limit”. It is sufficient to specify
the price. The broker understands that it is a limit order and that the price
given is the limit the trader is willing to bid or offer.
Stop order. A stop
order is an order to buy if the price hits a specified level above the market or
an order to sell if the price hits a specified level below the market. Stop
orders are used for two purposes. One is to limit the risk of a particular
trade by designating a price at which the position will be liquidated if the
market moves the wrong way (stop-loss). The order is to enter the market after
prices have gone beyond an identified price level.
Buy-stop order. This is an order to buy at a given price above
the market. When the indicated price is hit, the order becomes a market order.
That is, a buy-stop becomes an order to buy at the market if the price trades
at or through the stop price or if the price is bid at or through the stop
price. An actual trade need not occur to elect the stop. A bid at or through
the stop price will elect the stop and make it a market order.
A buy-stop order can
be used to enter a long position on market strength. As an example, if gold has
been trading between $520 and $525 per ounce and trader feels that once it goes
beyond $525 – a resistance point – the price will likely go much higher, a
buy-stop would be placed just past $525, perhaps at $525.50. Thus, the trader
would be in a position to catch the move if it occurs.
Sell-stop order. A sell-stop is an order to sell at a price
below the market. As with the buy-stop order, the sell stop becomes a market
order if the price trades at or below the stop price or if the market is
offered at or below the stop price. Once the stop is hit, the order is filled
at the best possible price. As with the buy-stop, the price need not be traded,
only offered, for the sell-stop to be elected. Such an order is used to enter a
short position on market weakness.
Stop-loss order. The term “stop-loss” is a generic term applied to
stop orders that are intended to limit loss. Such an order can be either
buy-stop or sell-stop. A stop-loss
order is entered concurrently to offset an existing position or another order.
If a trader is long five contracts of soybeans at $7.83, let’s say, but wants
to limit his or her loss to $100 per contract, a sell-stop order would be
entered at $7.81 (a one-cent move in soybeans is worth $50). If the market
moves up, the stop-loss order will not be filled. If the market moves down, however,
the order will be filled and the trader will be out of the market with a $500
loss ($100 X five contracts). The term “stop-loss” does not appear on the
order, only the word ‘stop”.
Stop-limit order. A stop-limit order is a combination of a stop
order and a limit order. Whereas the normal stop and a limit order. Whereas the
normal stop order converts to a market order when the specified price is hit, a
stop-limit order converts to a limit order. With a stop-limit order, two prices
are given: the stop price, which activates the order, and the limit price,
which is the limit the trader is willing to accept. The order would like this:
“Buy five soybeans at $6.75 stop $6.74 limit.”
A stop-limit order
should not be used as a stop-loss, since the order has a change of not being
filled. The advantage of this kind of order is that the order will not be
filled at any worse than the limit price; the disadvantage is that the order
might not be filled at all if the market moves beyond the limit price before
the floor broker can get the order filled.
Stop-close-only
order. This is an instruction to
sell or buy within the closing minute of trading. A sell-stop-close-only order
will be executed at or below the given price during the closing minute, whereas
a buy-stop-close-only will be executed at or above the given price. Often the
fill price will not agree with the settlement price because of the time span
during which the stop-close-only order can be filled.
Or-better order. There are times when a trader wants to enter
a buy-limit order above the market or a sell-limit order below the market.
Usually, such an order is placed only a few ticks away from the market and is
entered for the purpose of catching a strong breakout. If, for example, silver
is trading around $6.79 and the trader wants to catch what appears to be a
strong rally, he or she does not want to risk placing a market order or a stop
order (which becomes a market order when hit) because of the risk of being
filled at too high a price. The most this trader is willing to pay is $6.81.
The order would be placed “buy one silver at $6.81 or better (OB).” Without the
specification OB, the broker or the broker’s clerk would likely send the order
back as a bad order (buy-limit orders are always placed below the market). With
the specification OB, the clerk and the broker know what the trader intends.
Often, however,
traders will mistakenly add the designation OB to a regular limit order. This
is a tip-off to the broker that the trader is a novice and often will only
antagonize the floor broker, who feels that he or she always tries to get the
best possible price for the client without being told “or better.”
Fill-or-kill (FOK)
order. This order is not used
very frequently. It is an instruction to the pit broker to fill the order. If
the broker is unable to fill the order, he or she reports back “unable” and the
order is cancelled (killed).
Such an order is used
when a trader wishes to enter or exit a position quickly without the risk
associated with a market order. FOK orders can be used in thin markets or in
markets that have been hovering around a certain price level but for some
reason will not come to the price level desired by the trader.
VERY LOW
DRAWDOWN TRADING SYSTEMS
Good-till-canceled
(GTC) order. This order, also
known as an open order, remains in the pit until it is filled or until the
trader cancels it Most brokerage firms clear the books of all unfilled orders
at the end of each trading day, except for those designated as open orders, or
good till canceled. It is not uncommon for an open order to remain in the pit
for several days, even weeks, although it is important for the trader to
remember that an open order has been placed; otherwise he or she may receive a
surprise some day of a fill they were not expecting.
VERY LOW
DRAWDOWN TRADING SYSTEMS
One-cancels-the-other
(OCO) order. At times, a trader
wants to position himself or herself to catch a break regardless of the direction
the market moves. For this purpose, two orders can be placed, one above the
market, one below, with the stipulation that if one is filled, the other is canceled.
VERY LOW
DRAWDOWN TRADING SYSTEMS
Margin and margin
call. The term “margin,” as it
is used in commodity trading, is really a misnomer that has been carried over
from stock trading. When a trader buys stock, he or she can borrow half the
amount from the broker and put up the order half in cash. This is called a 50%
margin, which is the limit brokers are allowed to offer. (In the 1992s, brokers
were selling stock on 10% margin, which many believe contributed to the 1992
market crash.)
In the futures market,
a specific amount, also called margin, is deposited with the broker when a
trade is made. This margin money, however, does not purchase anything. It
simply serves as earnest money.
The trader has entered
into a contract either to buy or sell a commodity at a future date. No sale has
actually occurred, hence no money has been spent. If the market moves against
the trader, the margin will be used to pay for the loss as the position
declines in value. At a certain point, however, the margin money on deposit
will be insufficient to cover additional losses, and the trader will be asked
to deposit additional margin money or to liquidate the position and take the
present loss.
Thus, for each
commodity, there are two margin values established: initial margin and
maintenance margin. Initial margin is the amount that must be on deposit in the
account when a trade is initiated. Initial margin requirements vary
substantially from commodity to commodity and are subject to change by the
exchange depending on the volatility of the market. For example, in October
1987, immediately following the stock market crash, the margin for the S&P
500 contract was raised from $6,000 to $50,000 nearly overnight. The reason was
the unprecedented price swings that were occurring, which often quickly
exceeded the margin money many traders had on deposit.
Maintenance margin is
the minimum amount that must be maintained in the account to hold a position.
As a trade loses value, it erodes the amount of margin in the account. Once the
account balance is below the established maintenance margin the broker issues a
margin call. The trader is obligated to deposit enough money in the account
immediately to return the account to initial margin. Otherwise, the broker will
liquidate the position.
Minimum margin
requirements are established by the exchange. Individual brokers may, and often
do, establish higher margins than the minimums, but they may not establish
margins that are lower than the exchange minimums. Day trades-trades that will be exited by the end of the day-are
not subject to margin requirements. Any position held past the end of the
trading session, however, must be covered by the necessary margin amount.
Short selling. One of the most difficult concepts for the
novice commodities trader to master is the idea of selling commodity first, and
then buying it back later. “How can I sell something I don’t own?” is the common complaint. Actually, the
practice is not unique to futures trading.
To cite a carry
familiar example, consider what happens when a Girl Scout solicits orders for
Girl Scout cookies during their annual fund drive. Essentially, when the Girl
Scout takes an order for cookies, she has become a short seller. She has sold
cookies she doesn’t have, with the agreement that she will deliver the cookies
at a later date. The same thing occurs at an automobile dealership when a
customer orders a new car for later delivery. This time, however, the salesperson
will likely demand a deposit – earnest money – before accepting the order. The
salesperson has, however, sold a car he or she does not own, and which has not
yet been built. The salesperson is “short” the car (in the same way a person
might be “short” of cash). That salesperson, then, has become a short seller in
a futures contract.
The difference between
these two examples – the Girl Scout and the car salesperson – and futures
trading is that delivery of the cookies and the car will likely occur, whereas
delivery of a commodity futures contract rarely occurs. To avoid having to make
delivery, the short seller can simply become a buyer of the same commodity in
the same delivery month and offset the previous short position.
TRADING SYSTEMS FOR MARKET MAKERS
The same thing can
happen in our example of the Girl Scout cookies. Perhaps, after the Girl Scout
takes our order over to the Girl Scout leader, who then arranges for delivery of
the cookies and collection of money. By turning in the order (the contract),
the Girl Scout has liquidated her position by transferring it to the leader,
who is now the short seller. In the futures market, the trader who originally
took a short position liquidates that position by taking an offsetting long
position. The exchange functions exactly like the Girl Scout leader, in this
case, by assuming delivery responsibility from the trader. The trader’s profit
or loss is the difference between the selling price and the buying price, minus
commissions. The important point remember, though, is that short selling, or
taking a short position, can occur either to liquidate a previous long position
or to take a new short position. The procedure is the same.
(Jake Bernstein “How
The Futures Markets Work”, New York Institute of Finance 1989)
Chapter 6 “The Basics
of Trading Futures”