Limit and Market Orders
Using Limit and Market Orders to enter/exit a trade
The questions is:
A limit order is a resting order at a price to buy or sell. If the bid/ask is currently 1122.25/1122.50 you might have a limit order to sell at 1124.00. Your limit order will be sitting in a queue with other limit orders at that price and if the market moves up to that price and trades at that price then the orders ahead of yours will be filled first and then your order will be filled if enough buyers trade at that price. If the market trades above 1124.00 then your order will definitely be filled. If your order is filled it will be filled at your limit price and not above or below.
I am specifically excluding stop limit orders from this discussion.
A limit order can be used to enter a position at a predetermined price or exit a trade or a partial position.
A market order is executed in the market immediately at the best possible price. If you issue a market order to buy it will buy the lowest available offer in the market. Limit and market orders can be seen as the flip sides to the same coin. Limit orders are filled by market orders and market orders buy/sell resting limit orders.
Getting into a trade - Which to use?
What you are about to read is my opinion and you should research this subject further and tailor it to your trading method, style and signals.
In a fast trending market you need to use market orders. If you use a limit order it's going to be trailing behind the market and won't get filled until the market turns. In a churning trading market with contracting volume you are better off using limit orders to get the best fills at the edges of the market and reduce risk exposure.
This is easily said but obviously very difficult in practice. How do we know before the market reveals itself whether it's in a trading or trending mode? We can only see with hindsight. How do we know if a market is about to change from one mode to another?
Generally we don't know the answers to these questions but we can use probability analysis to work this out. If for example we've had 2 back-to-back trending days then the chance of a third trending day is greatly reduced. We may then switch our trading strategies from one type to another and with that we may switch the type of order we use from market to limit.
The converse is true as well. Say we have a number of narrow range low volume days in a consolidation pattern. We may have then set upper and lower limits of that range and trade in that range using limit orders but when we break out of the range and see volume in the market we may then decide that this is going to be a trending day and switch from using limit orders to market orders to take advantage of and get into the trend as early as possible.
The other thing to consider is whether or not your strategy is more successful with one type of order or another. I developed a strategy for trading the E-mini S&P500 (which I no longer use because it's become part of a more complex strategy) which worked well in back testing but in forward testing performed worse when using limit orders and better (than the back test) when using market orders. This was because once the strategy had signaled the market tended to move in the signal's direction fairly quickly and using a limit order didn't get you in on the really juicy moves. If the market moved in the opposite direction to the signal then your limit order was often filled but you were stopped out because that's when the signal invariably failed.
So when you're back testing any strategy you should also back test it with both limit and market orders and see which produce better profits. If you are forward testing a strategy and you're forward testing it with market orders you can paper trade the equivalent limit order part of the strategy in parallel and compare the results.
Getting out of a trade - Which to use?
Before entering a trade you should have a plan. That plan should include profit targets and stop levels.
Having said that and taking that approach one could easily place limit orders at your profit target(s) and a stop order at your stop level.
So why the question? Well the stop level generally shouldn't be violated. If the market is moving against you then the signal failed and you want to be out of the market and looking for the next signal.
What about the target? If you have a target objective then why not just place limit orders at the target levels and leave them. The reason for this is that you can take advantage of runaway markets in the direction of your trade if you don't place a target limit order in the market. You can also "work" the trade to gain more points than the simple strategy dictates.
What do I mean by this?
Getting out of a trade - A runaway market
If the market takes off in your direction and blasts straight through your target it will allow you to use a market order at a more advantageous price to take more money out of the market. This strategy is best used in liquid and fast moving markets. If you're not in a trending market then a runaway move in your direction is not as likely.
The strategy here is to cover your position into panic buying/selling as the market overshoots your target and take the extra points.
Getting out of a trade - Working the trade
You may have a target on a long trade of say 4 points. Instead of placing a limit order there you carefully monitor and watch the market. The market makes a panic move on high volume and quickly moves your trade to 2.5 points in profit. You know from market patterns and behavior that this is unlikely to reach your target right now as the market readjusts itself to the overshoot but your target is still highly probable. So you close out your position at the 2.5 point profit and when the market drops back down by 1 to 2 points you re-enter your long position creaming off a couple of extra points in the process.
The obvious danger to this is that the market doesn't retrace but instead motors on to your original target and you miss out on the extra points that you would have immediately gained. Again you need to make these decisions based on your back testing and analysis of the market that you're trading and finesse your entries and exits