All trades consist of at least one entry order and at least one exit order, with the orders being in opposition to each other (i.e. one buying and one selling order). As the trade entry always happens first (even if it is a selling order), it makes sense that it is the first order to be discussed.
Market or Limit?
There are a variety of different order types that can be used for trade entries (e.g. market, stop limit, market if touched, etc.), and each order type affects the trade entry in one or more ways. One of the primary differences is whether the trade entry uses a market order or a limit order.
The basic concept of a market order is that it is always filled, but at a potentially unfavorable price. Conversely, the basic concept of a limit order is that it will only be filled at the requested (or a better) price, but it is not guaranteed to be filled at all. This difference can have a significant impact upon the quality of a trade's entry.
For example, if a trader is entering a long trade on the EUR futures market (the Euro to USD futures market), and the bid and ask prices at the time are fluctuating between 1.4526 to 1.4527 and 1.4528 to 1.4529 respectively, the trade's entry might proceed as follows:
- Market Order - If the trader placed a market order, their trade would be entered at either 1.4528 or 1.4529 (depending upon what the ask price was when the order was filled).
- Limit Order - If the trader placed a limit order with a limit (i.e. requested) price of 1.4528, their trade would be entered at 1.4528 (or possibly a better price such as 1.4527), but it would not be entered at 1.4529 (or a worse price such as 1.4530).
This is a simple example, with a small bid/ask spread (i.e. one tick), so the difference is almost negligible. However, if the bid/ask spread had been larger (i.e. three or four ticks), or the market had been moving very rapidly, the difference could have been very significant (e.g. a trade on the EUR futures market using five contracts, and receiving a price that is three ticks different, would be $187.50 of either lost profit or additional loss).
Which Order is the Correct Order?
There is no single correct order because both market and limit are correct in different situations. The decision of whether to use a market order or a limit order depends upon several factors.
Some of the factors are related to the market being traded, such as the bid/ask spread, and how quickly the market moves. Other factors are related to the individual trade, and whether the trade being entered, or the entry price, is more important. In other words, if a trader wants to enter a trade no matter what, they should use a market order, whereas if they only want to enter a trade if they can do so at a specific (or at least favorable) price, they should use a limit order.
Knowing which order type (e.g. market or limit, stop or if touched, etc.) to use is important because using the wrong order type can cause unexpected results (such as using a stop market order instead of a market if touched order).