Market, Limit and Stop Orders Explained
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Market, limit and stop orders are are commonly used in the Forex trading market and to understand any one you also have to have an understanding of the other two. Let’s first take a look at market orders.
A market order refers to an order that an investor places to execute a trade at the current market price. Keep in mind that the concept of ‘current’ could very be quite different from that of ‘current’ in stock markets. In the Forex markets the changes are so rapid that the ‘current’ price can change in a flash.
Because the Forex markets are so extremely volatile, most market orders could have a marginal to a significant deviation from the price indicated on the investor’s screen. Unlike the stock market where you can place an order to sell a stock for a fixed amount and you can be sure you will get the quoted price; in the Forex market the likelihood of getting your asking price is small; at least a small differential is almost inevitable.
In order to offset the inherent difficulty in determining the correct market orders, it is necessary to have limit orders as well as stop orders.
Putting Market, Limit and Stop Orders to Good Use
A limit order is essentially a request to ensure that you will not purchase for anything more than or sell for anything less than the limit price.
Here’s a small example that will clearly explain how market, limit and stop orders can be used practically in the Forex market:
If the market rises to $1.1955 after you’ve purchased euros at $1.1905, you can take the opportunity to book in at least a minimum profit of 40 pips by placing a limit sell order of $1.1945 on your euros.
On the other hand, perhaps you wish to purchase a currency, say British pounds (GBP) and the current price of $1.7750 is too high for you. Placing a limit buy order for buying GBP at $1.7705 would indicate to your broker that you wish to buy GBP but the maximum you are willing to pay is $1.7705 per pound and nothing more.
This would typically have a specified time limit and if the price either does not rise or drop to the limit price before the expiry of the time limit, then the limit order is deemed expired and unfulfilled.
The main difference between a stop order and a limit order is that a limit order indicates an order to sell or buy at a minimum specified price or something better whereas a stop order indicates an order to sell or buy only when it reaches a specified price. After that, it is considered a market order, which means it is now subject to market fluctuations.
A stop-limit order is a combination of both- a limit order and a stop order. In a stop-order, your order gets executed when the market reaches a pre-determined price. It now becomes a limit order, which means your order will only get executed at the pre-selected limit price or anything better.
Market, limit and stop orders are valuable tools for any amateur investor who wants to dabble in Forex trading. Knowing how to leverage these concepts to your advantage can give you a definite competitive edge even amongst he more experienced Forex traders.