Orders are the way in which traders interact with CFDs, and make their trading intentions known. Suppose you want to buy a CFD position in oil, on the logic that reductions in supply will lead to higher prices. This goes from being a reasoned, researched concept into an actual trading position via an order, which is the instruction to buy placed with the broker by the trader. Orders can be made to build up a sophisticated structure of automated trading decisions, in addition to playing the primary role of interaction with the markets, and allow traders extensive flexibility to establish in-depth conditions to attach to each trade.
There are a number of different order types you’ll come across during your time as a CFD trader, and knowing what each of them means and does is an important step towards being able to implement them in your trading. Remember that orders represent the only tools of the trade you have in terms of interacting directly with the markets, so understanding what they do and when you should be use them becomes a crucially important consideration.
Buy orders are, fairly obviously, used to execute buying decisions. They are arguably the most straightforward order on offer, because buy orders simply represent a positive endorsement of the relevant market. Traders buy CFDs in order to profit from the market when it rises, with the profit portion lying in the middle of the initial buy price and the final sell price. Buy orders, which are usually filled swiftly (particularly when dealing with brokers directly, as opposed to trading on exchange), are best deployed in situations where you feel the relevant asset or market is likely to rise in value over the short-term, whether as a result of some economic indicator or other market performance factor.
Similarly, sell orders are broadly the same as buy orders, but on the reverse side of the deal. Sell orders can be effected as a starting point and a conclusion to a trade, with a view to closing out on the difference. With CFDs, it makes no difference whether a market is moving up or down – you can still profit from that market by ensuring you adopt their right type of exposure. So, for markets that traders anticipate are likely to fall in value over the shorter period, selling with a view to buying back at a later stage enables traders to profit in much the same way as if they had foreseen growth and bought the market when they took their exposure. This has no impact on leverage or earnings whatsoever, and is all just part of the flexible offering from CFDs.
Beyond the basics of buying and selling, which is fairly obviously conducted through buy and sell orders directly, the stop loss is arguably the next most commonly implemented order, providing traders with a crucial mechanism through which they can manage their exposure to risk. The stop loss works by setting a floor price at which a position will be automatically closed. In essence, CFD positions carry the danger of unlimited losses, and in especially volatile markets, this can make CFDs a highly risky option. However, stop loss orders can be deployed to give a guarantee of an exit point, with a view to minimising liability and capping the risk faced by the position. Stop losses can be set at points below the market price, and can be varied according to how the market moves throughout the duration of the trade.
On the flip side, stop limits provide the reverse functionality to the stop loss – capping losses on short positions, or indeed set an automatic profit-take level on long trades. When a trader takes a short position, he needs that position to perform poorly in order to make a return. If the position performs well, it will generate a loss, in much the same way as a long trade that underperforms. And as we know, CFDs have the capacity to deliver both unlimited earnings and losses with each transaction. The stop limit sets an automatic barrier price through which your position will be closed, and is set above the market value. This enables traders to commit to a more defined risk, while also enabling automatic closing to safeguard profits in long transactions.
Good Till Cancelled (GTC)
Alongside execution orders such as buying, selling and stops, there are also a number of more technical orders which specify how the trade itself will be conducted. These effectively automate the trading process to a large extent, by setting defined terms such as when a position should close and in what circumstances it might be cancelled. One of the main types of order that fall into this category is the Good Till Cancelled order (GTC). GTC means that a position will remain open indefinitely until such point as the trader agrees to close out. This means positions will be automatically held over night (with finance charges accruing) until you expressly cancel the transaction, allowing for an automation of trading intention that saves time and attention. GTC orders are best deployed with positions forecast over a period of more than one trading day, to give a degree of certainty to the trade.
Less Common Order Type – Trailing Stops
Arguably the most common point of contention with CFD trading is the degree of risk in every transaction. Regardless of whether a market is well reasoned or otherwise, the threat of things going wrong is ever-present, and with the full force of leverage on your back, this can be a highly daunting prospect. One of the more common means of counteracting this risk, inherent in the very nature of margined trading, is to introduce stop losses. Stop losses establish a cut-off point at which your liability is capped, and in the process provide a vital (paid-for) countermeasure to the risks posed by the transaction.
A slight variation on the traditional stop loss, trailing stops take the concept of limiting losses to a whole new level, providing an additional upside through their ‘trailing’ function which permits traders to automatically notch up their stops as the markets move into profit.
What Are Trailing Stops?
Where stop losses are a fixed baseline against which your position is protected, trailing stops are a much more flexible, albeit similar creature. Instead of fixing at one defined point, trailing stops move in line with the market, but only insofar as it benefits you to do so. When markets move in your favour, the trailing stop is lifted, and where markets move against you, it locks in place to deliver the stop loss effect.
For example, say you bought a CFD on Company X shares at a price of $80. A stop loss might be set at $72, such that if the market fell by 10% you would automatically cut your losses from that position.
A trailing stop, on the other hand, could be set at 10% of the market price, and would rest at the same $72 level upon entering the transaction. If the market moves up to $100, your stop would adjust to $90, effectively guaranteeing you a profit of $10 in the worst case scenario. If the market then reversed and took a nose-dive, your position would then be stopped at the $90 market – hence the trailing stop moves with the markets in you favour, before bolting shut when the price reverses.
As with anything in trading, the decision as to whether or not to deploy a trailing stop (and at what level) is a matter for individual, case by case assessment, factoring in both the volatility of the market and the cost-effectiveness for any particular transaction. However, with potentially significant benefits in protecting trading capital, trailing stops are certainly a consideration not to be overlooked.
The Bottom Line
Trailing stops are an amazing innovation for traders, and they can allow the risk profile of any given transaction to be somewhat reduced when the markets move partially in your favour. Of course, that’s not to say they eliminate risk – if that was the case we would be looking at guaranteed profits, which cannot possibly work for the markets. But what trailing stops do bring to the table is a flexible, robust protection against market reversals, fighting your corner to protect profits and minimise losses as far as possible – a handy combination for any CFD trader.