What are market orders, limit orders, stop limit orders?

What is a trade order?

In our other post, we discussed responsible cryptocurrency trading. Now, we will analyse the three most popular order types and how they work to offer more of a foundation in cryptocurrency trading. 

Note that throughout this article we are referring to “spot trading”. This means the trade is always settled immediately if there is a match. 

Think of trading as the exchange of assets between a buyer and a seller. Then we can call a trade order an instruction to exchange an asset like Bitcoin for another asset at a specific price or price range. Furthermore, all trade orders are either buy or sell orders since all traders are buyers and sellers. 

Remember that in a very basic sense a cryptocurrency exchange is made up of four components: a user interface, wallet, the admin panel and the trading engine. 

What is a market order and how does it work?

As mentioned above, all trade orders are either buy or sell orders - meaning the order to buy or sell an asset at a specific price. 

The simplest type of trade order is a market order. Market orders are usually placed by traders if they want to be certain a trade is executed. A market order is instant. Therefore, it is simply an order placed by a trader to buy or sell an asset like Bitcoin immediately at whatever its current price is. 

Example for a market order: I want to sell 0.75 Bitcoin (BTC) right now or as quickly as possible. 

Market orders are supposed to be instantly executed or, at least, as close to instantly executed as possible. When a market transaction has taken place and the order has been completed, traders refer to this as “the order has been filled”. A market order will always be filled instantly, otherwise it will not be executed. There are buy-market orders and sell-market orders. 

The potential disadvantage of placing a market order on an exchange is that you are agreeing to the exchange filling your order at the “best price possible for that time.” With this comes the limitation that traders who agree to higher prices get their market orders filled first and more price-sensitive traders lose out. On the other hand, market orders are filled first by default, as traders who have placed them have, by definition, agreed to the best available price of a particular asset. 

What is a limit order and how does it work?

While a market order is simply an order placed by traders to buy or sell an asset immediately at whatever the current price, a limit order in its most basic sense, is an order to buy or sell an asset at a specific price. Limit orders are placed with the purpose of limiting price risks. 

Example of a limit order: the price for BTC/EUR is currently at EUR 9,000 and you place a limit buy order for a limit price of EUR 8,500, then your order is meant to execute at the price of EUR 8,500 as soon as there is a matching sell order at this price or better.

Let's say a trader wants to buy Bitcoin at a specific price. The trader would place a limit order for Bitcoin at that particular price. For example, if the Bitcoin price falls down to EUR 9,000 and the trader would like to buy 1 Bitcoin (BTC), the trader sets the limit price to EUR 9,000. On the other hand, if the trader would like to sell when Bitcoin reaches EUR 10,000, then the limit price should be set to EUR 10,000 on the sell side.

It is important to note that if the price is set higher than the current price for buys or lower for sells, it may result in an immediate fill as there is a better price available than the limit price specified.

The disadvantage of a limit order is that if the limit price is not met by an interested buyer or seller in the time period specified, the order will not be filled. Second, and perhaps more importantly, timing is an essential factor in placing limit orders. Every order placed in an order book on an exchange is time-stamped. Trades that were placed first take precedence over orders that are accepted later, even if they have the same limit price as an order that was placed later.

What is a stop limit order and how does it work?

So while market orders are placed to be filled on the premise of time - immediately - at the current price, limit orders are placed to be filled on the premise of a set price within a time frame. This type of order is referred to as “good ‘til cancelled” (GTC). In addition to these two order types, the third order type we will highlight in this article is the stop limit order. 

Stop price and stop-limit order

A stop limit order is an advanced order type that is not instantly executed. The reason for this is that the trader places a limit on the price at which the order will execute. 

Therefore, a stop-limit order involves two prices: the stop price - which will convert the order to a buy or sell order - and the limit price - the maximum price for which a trader is willing to buy or the minimum for which he is willing to sell. 

At first a stop limit order is “Active”. A stop order is triggered when a certain price - the stop price - for buying or selling an asset is hit or crossed. Only when the order is triggered, will it be put into the order book with the limit price and then become visible to everyone.

Example of a stop limit order: an order is placed to sell 1 BTC at a price of EUR 8,900 (limit price) in the order book if the price of Bitcoin reaches or crosses EUR 9,000 (stop price).

The reason why this order type is also known as “stop-limit order” is that traders want to control the risk involved in the high volatility of Bitcoin. In this case, the trader wants to sell before the Bitcoin price falls below EUR 8,900. Once the stop price is triggered, the order will fill immediately if there is enough liquidity in the order book. 

In a nutshell, stop-limit orders are suitable if a trader is very price-sensitive and wants to protect assets against high market volatility. 

Margin trading

As you know by now, cryptocurrency prices are highly volatile which means sharp price drops and increases within just minutes are a regular event. As the cryptocurrency markets are relatively small compared in size to other financial markets, so-called “whales” - holders of large amounts of cryptocurrencies can influence the entire market. The more frequently large amounts of money enter the crypto market, the more difficult it gets for whales to substantially influence the market.

In its most simple definition, margin trading - unlike spot trading - means the investors sell and buy large amounts of assets using borrowed funds from a broker in addition to their own funds in an attempt to profit from volatility. 

Timing

For this reason, the timing and placing of stop orders when trading cryptocurrency needs to be carefully considered to ensure that quick price swings - also known as “whipsaws” - don’t put a trader at a disadvantage. Instead of placing stop-loss orders it may be more suitable in this case to actually monitor cryptocurrency price developments bearing your exit price in mind. 

Other order types

These three order types are far from the only order types but they basically constitute the foundation for all other types, some of which will be the subject of upcoming Bitpanda Academy articles. At this point, you already know about the fundamental tools you need for cryptocurrency trading and in our next article, we will build upon this foundation on studying how to read cryptocurrency trading charts.