Future Trading

Futures traders must understand orders and how each type of order works to successfully trade futures contracts and avoid costly mistakes that can occur from not fully understanding what each type of order does.

Futures trading is becoming increasingly popular as more and more people are discovering the profits they can derive from trading futures contracts and as the market becomes more available thanks to electronic trading. More than a billion futures contracts were traded last year, and that number is expected to continue to trend upward by industry experts.

The orders involved in futures trading are similar to those used in stocks, with a few refinements specific to the futures market. Investors who are new to trading or futures trading should take time to acquaint themselves with the different orders and what they do when executed.

Market orders

The most common futures contract order is the market order. This order allows the futures buyer or seller to specify how many contracts of a certain commodity for a set delivery month the trader wishes to purchase or liquidate. The order's price is not a set price, but instead reflects the contract's price on the market at the time the order is placed. Futures traders make these types of orders when timing, not price is the most important factor in the transaction. It's generally used to get in or out of the market quickly. A common application of the market order is the market on close variation, which buys or sells the contract at its market price at the end of the trading day. Market on open does the same at the beginning of the trading day, requiring the order to be filled at the opening price of the contract at the start of the trading day.

Limit orders

Another common order is the limit order. Limit orders set a price limit at which orders can be executed. The limit order can be filled at the price you specify or a better price. For example, a trader wishing to buy a June wheat contract at $2.05 when the commodity is trading at $2.30 would place a buy limit order specifying that wheat is to be bought when it hits $2.05, if it quickly drops below $2.05, the order will be executed at whatever price under $2.05 can be obtained first. In short, a buy limit order is only executed at the specified price or a lower price.

Sell limit orders set a price at which futures contracts will be sold. For example, a trader wishing to sell a June wheat contract at $2.30 when the commodity is trading at $2.05 would place a sell order instructing that the commodity be sold when the price hits $2.30. If the price swings upward quickly, the order will be filled at the most quickly obtained price over the $2.30 sell limit.

Stop orders

A stop order is the inverse of a limit order. A buy stop is placed above the market price, while a sell stop is set below the market price. For example, a trader seeking to buy July Corn at $5 when the current price is $4.75 would place a stop order instructing that the corn contract be bought when the price swings upward to $5. Traders use buy stop orders to "catch a wave," latching on early to a commodity that's price is moving upward.

A stop sell would specify that a contract be sold when the market price hits a set bottom. For example, a trader seeking to limit his potential losses on a futures contract currently trading at $5 per unit would set a sell stop at $4. If the price of the commodity hit $4 the order to sell would be executed at $4 or the quickest available price below $4. While the sell stop can limit losses, in some cases the price may drop so quickly that the contract is sold well under the sell stop price.

Stop limit orders

A stop limit order sets a ceiling and a bottom for a commodity, triggering an order if the commodity climbs to a certain price and another order if it falls to a certain amount.

There are a variety of other, more intricate orders, but understanding these basic orders will help investors make their first steps into the market. Before executing any order, traders should make sure that they understand precisely what the order will do, as it is easy to get stops and limits confused. A thorough knowledge and understanding of order types will prevent these missteps and protect your profits.