Order Types, Explained

Why do we need different order types?

Order types exist so that a person who submits an order to buy or sell assets retains some control over their order after it has entered the marketplace. Ultimately, they exist so that a person who is buying or selling stock, commodities or currencies can embed in a single simple instruction a lot of other smaller instructions.

When trading cryptocurrencies or other assets, all orders on an exchange fall into one of a variety of types that determine how an order is processed and when it is executed. On top of this, orders can be given special instructions that augment their parameters, often aimed at controlling the timing of execution. Nasdaq once had 136 order types that were devised by individuals with Ph.D.s in computer science, physics and mathematics who were specialized in high-frequency trading and implemented mind-bending logic into their mechanics; however, all of these orders were only derivatives of the basic “limit” and “market” orders.

Understanding the fundamental order types is essential if you want to be an informed trader. In what follows, we’ve compiled a list of all the major types and time-in-force instructions that can be found on various exchanges.

What is a market order?

A market order is essentially the most basic form of order type and is simply an instruction to purchase an asset at the best price currently available.

This type of order is the buyer saying, “I want this now at the best price available.” This guarantees the order will be executed, but it is not concerned with its price. Common among beginners, this order type is often considered the simplest, and it can be handy when you just want to quickly enter or exit a position and liquidity is abundant. Know that users placing market orders are considered “takers” because these orders are matched instantly and as a result “take” liquidity from the order book. This is as opposed to “makers,” which we will discuss now.

What is a limit order?

A limit order places a specific price that a trader wants to buy or sell at and is only executed if the market hits that price.

Whereas market orders are executed immediately, limit orders are executed at a predefined price, which is generally better than the current market price. For example, you believe Bitcoin (BTC) is about to dip. Implementing a limit order will allow you to set an execution price at, for example, $500 below the current market price by submitting an order to the order book. If Bitcoin drops to that price, the limit order sitting in the book will be executed and the trade will be concluded at your desirable price. This process allows traders to set limits and control their risks. As such, traders are afforded the luxury of knowing their price limits are set and that they will not be forced to constantly watch the market in order to execute the trades they want. The reason limit orders are seen as “makers” is that they are placed into the order book, which is literally what “makes” the market.

It should be noted that there is a chance that a limit order won’t be executed even when the market price reaches the limit price. This can happen when there are many limit orders set at a given price, and in most cases, these are going to be filled based on “price-time priority.” This means orders are first ranked by price, and orders at the same price are filled on a “first in, first out” basis. Hence, there is a chance that even if an order’s price is met, there may be too many other orders ahead of yours and the price may change before your order is executed. This is generally why it is encouraged to set limit prices a little above (for asks) or below (for bids) major psychological levels; for example, $10,100 (for asks) instead of $10,000. Of course, other traders are aware of this tactic as well, so it is sometimes helpful to look at the order book for prices that aren’t already inundated with orders, as these “psychological” levels may shift depending on the type of market participants.

What are stop orders?

Stop orders are similar to, but distinct from, limit orders. Where limit orders are actually on the order book, stop orders are only placed when the predefined price is reached, and they can be used in conjunction with market or limit orders.

The distinction is subtle, but the key difference is that limit orders are already placed on the order book and can be seen by anyone, while stop orders aren’t even submitted until the conditions are met. They can be set up to place a market or limit order, which can give traders increased flexibility.

Basically, a stop market order says, “If the price reaches X, buy/sell immediately.” This doesn’t mean you will necessarily get the price of X, but when that price is reached, a market order is immediately placed to buy at the best current price. Alternatively, a stop-limit order says, “If the price hits X, place an order to buy/sell at Y.” Note that X and Y can be the same price, but they don’t have to be. So, you could theoretically have a trade that goes, “If Bitcoin hits $10,000, place an order to buy it, but only at the price of $10,000.” Alternatively, you could set it up as follows: “If Bitcoin hits $10,000, place an order to buy it, but only at $10,100.” By combining these layers of instruction, traders can create complex strategies and manage risk more effectively.

What are scaled orders?

Scaled orders use several limit orders in order to buy or sell incrementally. This can help average out the impact of market fluctuations over time as well as mitigate the effect caused by a large order.

Sometimes, a trader wants to make several smaller purchases over a range of prices as opposed to a larger one at a fixed price. There can be a couple of reasons to do this, and one is “dollar-cost averaging.” Basically, traders often stand to get better value on their trades if they “average” their purchase or sale with trades that only are executed if and when the market moves in the desired direction. This tends to smooth over market volatility and can, on average, yield better results as traders buy into or sell out of positions.

The other reason is not to reveal to the market that a single large order is pending execution. This is done to minimize the effect of your trade on the market. Not only can large orders have a significant impact on the market by moving prices, but they can also have psychological effects by influencing other traders. In order to avoid this, a massive buy or sell could be split up into, for example, 10 smaller orders placed across a range of price levels. And for the most part, this would just look like regular activity on the order book.

What are time-in-force instructions?

Time-in-force instructions can modify limit orders by placing time constraints on when they are executed or canceled. This again increases the degree of control a trader has and takes away the chance of forgetting about an older order that they may no longer want.

Let’s say a trader has an old order on the books from weeks ago that is no longer desirable based upon current conditions. If unchecked, that order could end up being executed and be a costly mistake for the person who placed it. To account for this, traders can tune the “time-in-force” instructions on orders to limit how long they stay active without being executed.

The most straightforward instruction is “good till canceled,” which is simply saying, “Leave it on the books until it’s executed or I cancel it.” This is obviously the default for many trades, as it doesn’t give much instruction at all. There are also “immediate-or-cancel” orders, which are automatically canceled if they cannot be filled as soon as they are placed on the order book. Similarly, the “fill-or-kill” instruction will cancel the order if not fully filled by another order after it has been placed on the book.

Then there’s the “day” order instruction. This simply cancels the order if it is not executed by the end of the trading day. For even more flexibility, traders can use the “good-till-date/time” instruction, which simply means an order will stay active until either filled or a predetermined time is reached.

What are post-only orders?

One last type of instruction that can be embedded into the logic of an order is the “post-only” option, which makes sure that an order is placed if and only if it cannot be immediately filled.

If a buy (or sell) immediately matches an opposite sell (or buy), the orders are crossed, resulting in a trade. Many times, a trader actually does not want to place an order if it will be filled immediately by another resting order — the trader wants to avoid paying the taker fee when placing limit orders. This is tied to the nature of makers and takers that we previously discussed. Generally speaking, exchanges will have notably lower fees attached to limit orders than they will for market orders, as they are the ones providing liquidity. Hence, post-only orders basically say, “Only place this order if it is going into the order book and not being immediately filled, avoiding the possibility of paying a taker fee.”

As you can imagine, by stringing together these various order types and instructions, traders can have significant control over how and when trades are executed. This becomes the basis for increasingly complex strategies when combined with the right indicators and other tools. Note that not every exchange will support every order type or instruction, but major ones such as Binance or CrossTower will have everything outlined here. Now that you understand the differences, you should be able to begin placing orders with the increased confidence of understanding how they are going to play out, which is essential for any trader.