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This chapter is from the book

How to place an order

Let's do a bit of time traveling and assume you've finished this book, you've done your homework, you've opened an account with a commodity broker, and you're ready to place your first trade. What's the procedure? Very simply, you need to instruct your broker (either by telephone or by Internet order entry) which commodity you want to trade, the quantity (in terms of numbers of contracts), the month, and whether you want to go long or short. You then need to tell your broker how you want your order to be executed.

Market order

This is an order to buy or sell at the prevailing price. By definition, when a commodity is bought or sold "at the market," the floor broker has an order to fill immediately at "the next best price," but in reality, it is the "next price." I've seen advice in trading manuals that effectively states that you should never use a market order. The reasoning has to do with the bid/offer spread.

In an auction market, traders make bids and offers. The bid is the price put out for immediate acceptance. The offer (sometimes known as the "asked price") is the price at which the seller is "offering" for immediate sale. In most cases, unless the floor broker is able or willing to pass along the edge to the customer, you buy at the offer and sell at the bid. You potentially lose this difference—it may be small—but you can lose it by placing a market order.

I totally disagree with the advice never to use market orders. For one thing, floor brokers are out there who are able to buy the bid or sell the offer and pass this along to us, the customers. If I consistently don't like the price fills received by a certain floor broker in a certain market, I go out and find myself a new one, and there are many around. In the markets I trade actively, I personally know the brokers on the floor who are filling our orders. This personal bond, I find, makes for better fills. However, this aside, there's a more important reason to use market orders in many cases, even if you have to give up the bid/offer spread. For one thing, if you use a limit order at a specific price, there is no guarantee you will be filled. The market may have to move away from the direction you think the market is moving to get filled. Most importantly, with a market order, you know you will be filled. This is important in a fast moving market, because these are the ones you most want to be in. By definition, you will be filled on every bad trade at a limit price (because it has to move against your bias first), but you could miss some good trades. If a market is moving at 50, 55, 60, 65, 60, 70, 80 to close at 120, and you place a market order at the 60 level the first time you see 60, you might get 60 or 65 or even 70, but you know you are in a trade that is at least starting out right. If you limit your price to 55, you might never get on a good move. Who knows? The next day it could open at 150.

Limit order

When you place this type of order, you know what you will get in the worst-case scenario (you could get better), but there are strings attached. With a limit order, the floor broker is prevented from paying more than the limit on a buy order, or less than the limit on a sell order. Unless the market is willing to meet your terms, you will not get in. The drawback of a limit order is that there is no guarantee you will get in. You could miss some markets. You are not even assured you will get in if your limit is hit. In the preceding example, if you place a limit order to buy at "50 or better" and the market touches 50, this may be your trade, or it may be someone else's. You can be only reasonably assured you are in if the market trades lower than 50. Nothing is more frustrating than to place an order to buy at 50, see the market trade there once, and call the floor to see whether you are filled, only to receive an "unable" just as the market's crossing 75. That's not to say there isn't a place for limit orders. I like to use them in quiet, back-and-forth type markets so as not to give up the slippage seen with a market order. I also use them to take profits on a good position. I try to let the market reach out to my limit price. After all, if the market doesn't reach my limit, I can always revert to a market order.

Stop orders

Stop orders, or stops, are used in two ways. The most common method is to cut a loss on a trade that is not working (also known as a stop loss order). A stop is an order that becomes a market order to buy or sell at the prevailing price only if and after the market touches the stop price. A sell stop is placed under the market, a buy stop above the market.

For example, you buy July Sugar at 11¢ (1100). You buy it because your analysis suggests that the market is going to go higher. However, you do not want to risk more than approximately 50 points, so you give your broker a sell stop, to "sell July Sugar at 1050 stop." As long as the market moves higher—fine and good—your stop will not be elected. However, if the market trades down to 1050, your stop loss automatically becomes a market order to sell. Depending on the speed and direction of the market and the skill and luck of the floor broker who has your order, you will be out at the next best price. It most likely will be 1050 or slightly below, say, 1049. In a fast market, it could be lower, say 1048, or it even could be higher, say 1051 if the market upticks after the stop is hit.

A stop also can be used to lock in a profit and cut a loss. In the sugar example, let's say the market starts to move in your favor, up to 1150. You might decide to cancel your 1050 stop and move it up to 1104, thereby assuring a worst-case break even or a small loss after commissions. The market continues to move up, reaching 1210. You move your stop up to 1150, thereby assuring a profit on the trade, even if it trades back down. This is, at times, termed a trailing stop, which occurs when you move your stop with the market. A buy stop is placed above the market to liquidate a losing short position. You go short sugar at 1201 and place your buy stop above the market at 1253 to limit your loss. You can always cancel and move your buy stop lower, should the market move in your favor.

Stops also can be used to initiate positions. They're used by momentum traders who want to enter a market moving in a certain direction.

For example, if a trader believes gold can trade above the psychologically significant $400 mark, it will move higher. He places a buy stop at 401. If the market remains under 401, he never enters the market and potentially avoids a "do nothing" or worse, a losing trade. If the market reaches the 401 level, he will be in at the next prevailing price. The hope is that the market keeps moving, to 402, 403, and on up. Once in, the trader can place a sell stop at, say, 396, to limit losses should this turn out to be a false signal. Of course, the risk is that the market could run up to 401 and back down again. In this case, it would have been better to limit the price at a lower level or not use the stop to initiate the trade at all.

However, when used correctly, these can be good orders to enter with. A sell stop would be used under the market to initiate a new short position if not in the market. There is, in addition, a variation of a stop order called a stop limit. With a stop limit order, if the stop price is touched, a trade must be executed at the exact price (or better) or held until the stated price is reached again. The risk with the stop limit is the same as with a straight limit. In other words, if the market fails to return to the stop limit level, the order is not executed, so I normally do not recommend its use. It can, in a fast moving market, defeat the purpose of the stop (to stop your loss).

Market if touched orders

Also called MITs, these are the mirror image of stops. An MIT is placed above the market to initiate a short position.

For example, you are long platinum 405, and you want to take profits at 410. You could place a limit order to sell at 410, but you cannot be assured that you will be filled if the price touches 410. The market would have to trade above 410 to have a reasonable assurance that you are out. An MIT at 410 becomes a market order if 410 is touched, which will ensure you are out at the next prevailing price. MITs tend to be filled better on average than stops because you are moving with the prevailing trend. In a market that moves 40950, 410, 41050, 411, an MIT at 410 would be filled at either 410 or 41050. If the next tick after 410 was 409, you certainly could be filled at 409 (because the MIT became a market order), but it is more likely that a buy stop at 410 would be filled at 41050 in this example. An MIT could also be used to initiate a new short position above the market. An MIT to buy is placed under the market to exit a short position or enter a new long. If the market is trading at 100, you might place an MIT to buy at 99, but you would place a stop to sell at 99. See the difference?

These are the major types of orders you will use. There are other exotic orders I've not found useful in practice, with the exception of the OCO. OCO stands for one cancels the other. It is used on both sides of the market either to take profits or cut losses; one cancels the other. For example, you buy silver at 700, you want to take profits at 750, or cut the loss if the market trades down to 675. You could place an order with your broker to sell at 750 or 675 stop; one cancels the other. In this way, you are assured that if one side is hit, the other side will be canceled. This is significant in volatile markets. If you placed two separate orders, and the market first runs up to 750, takes out your position at a profit, then trades down to 675, you could be sold into a new short position you didn't want.

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