Why are you Chasing the Trade?

Do you find yourself doing this? You have run a search a found a potential candidate to trade. It has passed the 151 point inspection and you have topped it off with a buy signal. Success! You venture over to your account to get started and just as soon as you type the symbol and quantity, you stop like a deer in headlights. Frozen and paralyzed by the next thought entering your mind.... Market or Limit?

Juxtaposition? While some have heard "one size fits all" methods for order placement, there is no such thing. When you are about to take a trade there are several elements to consider before you make your choice. While this is not a very difficult decision for those that trade during the day, if you are submitting your order while the market is closed then this becomes a difficult judgment to make. Let's start with a definition of each order and a few pro's and con's with using them.

A Market Order is an order to buy or sell immediately at the next best available price. These orders DO NOT guarantee a price of any kind, but do guarantee you get into the trade quickly. If you are trading a stock or option, the price should be close to the asking price of the instrument you are trading. However, in an overnight scenario, fast market, or volatile conditions you run the risk of the price deviating away from this ask price. Meaning if I place a market order to be filled in the morning, the stock can gap up or down and I could pay a price that is completely different than what I was expecting. The real upside here is that I get filled and get in a trade on this stock at all costs.

A limit order sets the specific price you are willing to pay for your trade. You are essentially telling the market maker I am willing to pay "x" or better for this trade, or I am not willing to take the trade at all. If the market opens better than what was anticipated, you will miss the trade. The downside here is if the stock happens to open the morning running like you had expected it to, then you are left on the sidelines watching it move, or chasing the stock and paying much more for the trade than you initially would have if you had used the right order.

Another method of entering an order that has been wildly blown out of proportion is to "split the difference" between the bid and ask. If you are trading during the day and the price is idle, why not? If you are entering your order at night, are you nuts? I would assume that you will miss the trade more than 75% of the time doing this. Personally I will only do this during the day when prices are stagnant. I will throw it out there for a few minutes and see if I get filled. If it doesn't fill I quickly bring it back to the ask to get into the trade. If I leave the order there and the market continues to move, the ask price increases, and I keep moving the order up until I pay a price well over the initial ask price. Not a great idea.

The question is how bad do you want to be in this trade. If you want to be in and saving a few nickels or dimes is not an issue, place a market order and get in the trade. If you are an option trader (where the nickels and dimes are a big percent of your trade), and don't want to be at the mercy of the market maker, I have a suggestion. Let's say one night you stumble across a trade and the price of the option is 3.80 by 4.00. You could put in a limit at the ask, but what if you are bullish on the stock and imagine it will kick off the morning with a bullish open? Have you ever tried submitting a limit order higher than the ask price? Let's assume after a long deliberation I felt I would be willing to pay as much as $4.50 to participate in this opportunity. I could place my order at a limit of $4.50. If the market opens at 4.10 by 4.30 let's say, and I have a limit of 4.50....I will pay 4.30. Remember, a limit will give you YOUR price or better. If the market opens too high (beyond your limit) then yes, you will miss the trade. At least you have a little buffer there to anticipate a higher open.

These strategies should apply to both buyers and sellers. This is a fundamental component of trading. Once you understand that different scenarios can call for different orders, knowing the advantages and disadvantages of each will help you make the best decision for each trade.

We will leave the door open on this discussion to post comments and you feel fit. I will follow up to this in the future with discussions on other order types such as stop orders and stop limit order entry.

In the meantime, I am off to spend time with my wife and kids. Have yourself a great day.

Great discussion! Will pass this on to others with the same quandry.

....you had a secret camera over my shoulder this morning didn't you...as I was contimplating the exact same scenarios...Oh, and yes, I ended up chasing the trade. :)

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About me

  • I'm Option Addict
  • From Saratoga Springs, Utah, United States
  • I am a professional trader and an instructor for Investools. I've had relations with the markets for 9 years. Born in Concord, CA, but reside in Saratoga Springs, Utah. Father of THREE, Husband of one.
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