A Limit Order may be necessary during certain market conditions. Using a Market Order may cause you to get a bad price is some situations. Typically Breakout Theory’s trading system uses market orders, because the system seeks larger and longer term trends. With Breakout Theory we are not seeking to beat the spread, we are here to beat the market.
Other Types Of Orders
Nevertheless, there are exceptions to the rule, and occasionally using this type of conditional order is wise. There are a few instances listed below where you may want to consider. All situations are unique and not all scenarios are listed here. The are some consideration which should serve as a guideline of when you should use conditional orders.
Situations You May Want To Use a Limit Order
Volatile markets – Risk can significantly increase as price action gets wider in a shorter time period. Anytime there is a question as to what price your trade will be executed, you should always use a limit order. Volatility in any financial instrument that your are trading should be observed, as it severely skews the risk reward profile of the trade
Risk / Reward Formula is off balance – Again, risk /reward calculations are based of current market price. If the price fluctuation are so great that a specific risk figure cannot be calculated, it is highly advised to use a conditional order. In a more simple sense, you always want to know your bottom line. Using a limit price give you an exact figure in which you will enter a trade, thus defining total portfolio risk.
Low Volume Stock – Breakout Theory does not trade low volume stocks. Any stock whose volume is less 1 million shares traded daily is considered low volume. There are exceptions to the rule. Limit orders are highly recommended when trading low volume stocks. The lack of volume causes liquidity issues and price action gets very choppy. During breakouts in low volume stocks, the situation can become worse and as all the factors just described above are amplified.
Market Crashes – Using a limit order during market crash is mandatory. However it’s very difficult to get filled in this type of market environment. Most likely your order will stand open for quite a period of time. During market crashes, liquidity dries up and there are no buyers of stock. There is a huge imbalance, and the efficiency of the market breaks down.
Wide Bid / Ask Spread – Having a wide spread again skews risk, as entry price greatly differs from exit price. You want to make sure you get a competitive price, and calculate risk more effectively. Often times when trading breakouts you can get stopped out in a short period of time. It is essential that you understand what price you are “most likely” to
Low Priced Stock – Stocks under $20 typically have all the issues listed above. There is little participation in the smaller cap stocks. When trading lower priced stocks it’s a good idea to use a limit order. The lower priced stocks volatility is very high a $1 move in a $10 stock is a 10% swing. That swing also translates into total portfolio value change.
Notes: Where you buy and sell based on technical analysis is a factor of position size. Thus, defining your total portfolio risk. For each trade, the loss calculated in a losing scenario should never exceed 2%. Limit orders in essence, try to reduce transaction costs by minimizing slippage, the bid/ask spread, and liquidity issues. There are other ways to compensate than using a conditional order. All this can be overcome by taking those factors into consideration, and adjusting your postion size.