Trading using limit orders – complete EURUSD trading process example
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In a forthcoming article, we will look at market orders, whereby a quote received from the broker lends the trader a price at which to buy or sell immediately (the ask and bid prices, respectively) and we shall learn that such trades are traded in real time ‘at the market’.
In this article, we will look at another type of order, which can be placed in advance of the market reaching a particular price.
In other words, the order is set and the trader then waits for the market to ‘come to him’ or ‘come to her’.
In the worked example, from today’s live trading (28 April, 2017), the Euro US Dollar (EURUSD) pair was chosen – a popular, liquid currency pair with good momentum on offer during the European session normally.
There are 20 figures used as illustrations for this article, namely: figures A And B, and figures 1-18. To enlarge an image, simply left-click on it to view the image in more detail
What is a limit order?
The limit type of order is used for trading when the trader expects a reversal of the price at a chosen, designated level at which the trade will be opened, if and only if the price reaches that level or goes beyond it.
Limit order metaphor
A metaphor for thinking about the limit order concept is the price ‘reaching its limit’.
Once something has reached its limit, it cannot go further, and needs to come back.
Thus, if the market price of an instrument is going up, a sell limit will sell the instrument once it goes up to what the trader perceives to be its ‘limit’.
If the market price is coming down, the buy limit order will execute a buy trade when the price comes down to the limit order price.
Therefore, a buy limit order, is set at a price lower than the market is currently trading.
A sell limit order is an order set to enter the market at a higher level than the market is currently trading.
The contrasting pending order set are the ‘stop’ orders, a buy stop being a buy order in the upward direction above the current price, and the sell stop being a sell order below the current price. These will be covered again and again, and in detail in another article, so keep reading even if you do not ‘get it’ yet.
Hypothetical limit order example: DAX cash index
Let’s say the German DAX cash index (an index of Germany’s leading stocks) is trading at 19243.5/19244.5 with a spread therefore of 1 DAX point.
Most charting platforms will plot the price using either the bid price or the mid-point between the bid and ask price, that is the SELL price offered by the broker, or the average of the sell/buy prices, respectively.
Options may exist within the platform to show additionally the ask price, such as below in the Metatrader platform (figure A), whereby a line will be added showing the current ask price.
In Metatrader 4 trading platform, right click and select properties, or simply key ‘F8’ and select ‘show ask line’ under the common tab.
The trader thinks that rather than entering the market now, the price is likely to retest a level such as 19235 (i.e. head down before going up).
Imagine that there is insufficient room, or confidence for the trader in this example to actually sell (trade) the market down to 19235.0 from 19243.5, but the trader does think that the 19235 level is a high proability candidate for a strong bounce, forecasting a catapulting of the price back up to the 19275 area, a move of 40 DAX points upwards.
In such a situation, the use of a buy limit order will allow the trader to get into the market at the desired price, with a preset order for the broker to execute, and a stop order that is fairly tightly below the support (in case the support fails, e.g. at 10 points below the entry, for a loss of 10 points in this event).
For example, the trade may place a buy limit order for a buy order to be instigated at 19236 (ask).
Therefore, when the bid price reaches 19235 (assuming the spread is equal at 1 DAX point), at that moment, the DAX will be bought at 19236, because the ask price will be at the buy limit order entry price, at which it will be converted to a market order.
Rather than entering the market with a buy trade at present time, a better bargain can be had by waiting to enter at a lower level. We will be looking at many trading strategies that will employ this risk reducing and profit increasing principle in this pro trader fast track trading course.
Trade planning in limit order execution
The buy/sell limit order allows the trade to be planned out in advance, not only the entry level, but the stop loss at entry and take profit at entry may also be setup in advance, in addition, of course to the position size.
The orders when placed for a sell limit and buy limit with pre-trade risk management parameters will be as follows:
SELL LIMIT (with BUY STOP LOSS [EXIT], BUY LIMIT TAKE PROFIT [EXIT])
BUY LIMIT (with SELL STOP LOSS [EXIT], SELL LIMIT TAKE PROFIT [EXIT])
Figure B provides a visualization of these four types of trade in metatrader and where they are supposed to be headed if used for entries.
In both cases, the stop loss order and the [limit] take profit order both have the effect of closing the trade either at a predefined acceptable level of loss (the stop loss), or at the predefined acceptable profit target level (the [limit] take profit).
Full workthrough from today’s live trading
From today’s trading, we take the reader through a limit order using the Metatrader platform and trace the evolution of the trade in images and commentary.
Figure 1. Trade Idea. Selling the Euro off a resistance level – M15 EURUSD candlestick chart
Figure 1 shows a EURUSD chart, the timeframe being 15 minutes per candle.
Rationale for limit order price point
Floor trader pivots (pivot points) show that the price has struggled to close above the mid-resistance 2 level, while the high of yesterday and the resistance 1 level have been clearly exceeded in a strong 25 pip upmove, likely to have resulted from news.
Assuming that the MR2 level struggle is a sign of the market being overcooked, a sell limit could be placed above the current price, with a stop loss at or above the current highs, and a suitably placed take profit, according to say, a risk:reward 1:2.5 or above trading rule.
It is also Friday and the end of the month, and we are not expecting huge ranges to be carved out, neither that the European economy is expecting a miracle today.
Furthermore, technically, the M15 chart shows clearly a normal reversal candle indicating potential impending weakness, and that candle is looking to close well within its lower 25% region, another sign that bears might take control for a time.
But this is only the 15 minute chart, so let’s await a retest of the MR2 to get a better entry to go short. A sell limit order will do the trick.
Figure 2. Setting up the sell limit order (1), by opening the order window.
Setting up an order in Metatrader 4
In figure 2, the ‘F9’ key has been pressed, or some other of several ways to open up the NEW ORDER menu in the platform, in this case Metatrader .
The current bid and ask price are revealed, and the type of order needs to be changed to ‘sell limit’ using the dropdown menu.
This is done in figure 3, below.
Figure 3. The pending order window set to sell limit in metatrader 4, with the EURUSD chart in the background.
Figure 3 shows the pending order being set up by the trader.
The volume shows the number of standard lots to be traded.
The stop loss allows a pre-defined [buy] stop loss order to be placed at the same time as the limit order is placed.
It is a buy stop loss, because once we are in the sell (selling Euros, buying US dollars in effect), we must buy back the Euros at a later exchange rate in order to realise a profit/loss.
Similarly when buying shares, one must sell the shares back into the market to realise a capital gain; it is as though the transaction pair is the share vs. the currency the share was bought in. It is an exchange transaction in the literal sense.
A take profit can also be placed (note that this is essentially a buy limit order, therefore at the ask price, which will have the effect of neutralizing the position and thus, have the effect of closing the trade).
Finally, on many trading platforms it is possible to add a timed expiry to the order, for example, after 15 minutes, or 1 hour, or whenever the trade is no longer desired if not filled. This will automatically delete the order if it is not filled at the expiry time.
Figure 4 shows what the chart looks like after the order has been placed. The – — – — dot-dash lines show the orders that are now on the chart.
The other lines are related to the floor pivots and the dotted red line just a visual tool to inform the trader of the price at which the high of the previous candle topped, and thus where to place the stop at or just above.
Figure 4. A placed sell limit order, with pre-defined stop loss and take profit (modifiable)
Risk management – stop loss, take profit and risk reward
The stop less (buy stop order) has been placed exactly at the high of the previous candle, plus 1.1 pips spread at 1.09488.
It is the ask price that will trigger the stop, since it is a buy stop order essentially.
When will the sell limit be converted to a market order?
The sell limit order is at the MR2 line, less the spread, at 1.09412 bid. A bid price of 1.09412 will trigger the entry.
The stop loss is therefore going to be 1.09488-1.09412 = 7.6 pips from entry, including an assumed spread of 1.1 pips, the current spread.
Initial take profit setting
The take profit order has been set at 1.0912 ask, just tucked above where the 8 simple moving average currently sits, 1.09412-1.09120, i.e. 29.2 pips below the entry price.
Note that the price shown in black highlights to the right of the chart is the mid price between the bid and ask, and that the take profit price in this case, refers to a buy limit order, therefore, the ask price.
For the take profit to be hit, the bid price therefore needs to reach about 1.09109 (1.1 pips lower – assuming this spread stays the same) for this buy limit (take profit order) to be triggered. It is the ask price that needs to reach the specified take profit level. Remember, the ask price is the brokerage price at which the broker will sell the instrument – it is what they are ‘asking’ for the instrument, therefore it is the trader’s BUY price.
The bid price is what the broker (and thence at least one other trader) is willing to ‘bid’ for the instrument. Therefore, it is the price at which the trader can SELL into the market.
Calculating the initial risk to reward ratio
The risk to reward then is 7.6:29.2 = 1:3.84 risk to reward ratio. We are willing to risk 7.6 pips in order to gain 29.2 pips at the outset.
Figure 5 shows the chart labelled manually, although these prices and the type of orders are shown to the left of the lines, out of the scope of the image.
Figure 5. The sell limit order with stop loss and take profit labelled.
Adjustments to the trade can now be taken, simply buy clicking on and then dragging any of the three lines around the chart.
Adjusting the take profit order (buy stop order)
In figure 6, below, the take profit has been moved up to 1.09211, or 19 pips from the entry price plus the 1.1 pips of spread, a more modest, yet still acceptable, 1:2.5 risk to reward ratio, with the take profit sensibly sitting just above the R1 resistance floor pivot point.
Figure 6. Take profit adjusted to a more modest level, but maintaining 1:2.5 risk reward
The trade has still not been filled at this point, though has come within 1 pip of being so. Everything is planned out in advance, so that we can let the market come to us, and let the trade take care of itself.
Figure 7 shows what the order looks like in the terminal region of metatrader, whose default placement is below the charts.
The order number has been obscured, as has the volume amount traded.
Figure 7. Order number, time, type, volume, instrument, price, stop loss, take profit and current price, for a sell limit order.
Figure 8 shows the tick chart from the market watch window, which shows the bid price being plotted tick by tick in real-time.
If the ticker chart ticks up 1.9 pips, then the sell limit order will be filled and the trade will be placed in the market, along with the stop loss and take profit orders earlier defined.
Figure 8. Tick chart alongside the sell limit order on EURUSD M15, showing the current bid price.
Sell limit order conversion to market order – order filled
In figure 9, the order has finally been filled and is shown in the terminal window, now with added columns, namely: commissions to broker, overnight interest paid (may be positive or negative depending on interest rate differential and the timing of interest payments overnight), and finally the profit/loss on the trade at present.
Figure 9. Order number, time, type, volume, instrument, entry price, stop loss, take profit, current price, commission, overnight interest and net profit/loss on trade (obscured).
There is nothing much more to do except for wait out the result of the trade and monitor the progress of the price action.
Evolution of the trade with the desired stop loss and take profit orders in place
Figure 10 shows the first evolution of the sell limit trade, now that it has been converted into a sell order that is already in the market, with its concomitant stop loss and take profit orders at -7.6 pips and +19 pips respectively, for a risk to reward ratio of 1:2.5.
Figure 10 EURUSD Sell limit trade now sell order in the market, with stop loss, take profit and risk management parameters (risk reward ratio shown by the red and dark green blocks).
Figures 11, 12 and 13 show the trade evolution over the next few hours.
Figure 11. EURUSD M15 chart 45 minutes after entry, with target areas marked
Triangle trading pattern
In figure 11, notice that a triangular pattern of consolidation seems to have emerged, being tested 4 times to the lower side, and twice to the upper side. This can be a continuation or reversal pattern, however, that this has now broken to the downside is a positive sign.
Quite soon after this breakout, after a similar mini-ranging movement, the trade then quickly reaches the 1:2 risk reward level (see figure 12).
Figure 12. Evolution of EURUSD trade triangle break
As figure 13 shows, after the break of the triangle to the downside, we now appear to be within another tight range, this time though, we can draw in the diverging wedge, using dotted lines here as each side, upper and lower, have only been tested twice, for a total of four times.
Furthermore, the lower side of the triangle from figures 11 and 12 is shown as an unbroken line, as it now becomes resistance, having been tested four times, it should support our sell trade.
Figure 13. Progression of trade with converging and diverging triangular/wedge formations
Figure 14 shows the trade almost completed, reaching the reward area to within 1.5 pips.
Notice also that the descending wedge lower line is just above the 2.5 reward area.
Figure 14. Edging closer to the take profit area of the 1:2.5 risk to reward trade
Intervention: trailing the stop up
For this reason, following the axiom ‘don’t let a winning trade turn into a loser’, we elect to bring the stop loss up to 1.25 of the risk, locking in a 1:1.25 risk reward, not optimal, but if the market decides this wedge is to catapult the price back up to the top, the trade would be back to where it started or worse, so this is a sensible option in this case.
Thus, the stop order (buy stop) is now the guarantor of a profitable trade, provided there is not some freak, very low probability instance of chronic slippage at or through that particular level.
Figure 15 shows the new [buy] stop loss order, which will have the effect of closing out the trade at a profit of 1.25 x the size of the original stop loss, but in (+)profit rather than loss(-) terms to the trading account.
Figure 15. Stop loss moved to 1:1.25.
The new stop loss, in its essence a trailing stop loss, because we are ‘trailing it down’ with the lower time frame swings down (kinetic energy movements), followed by smaller corrections up (potential energy gathering), is just a fraction above the high of the most recent swing correction and is labelled in figure 15.
The figure shows the 5 minute chart (incorrectly labelled as 15) to demonstrate the swing taking place at this lower timeframe, suggesting the stop is positioned reasonably, just above the most recent high in a correction within a series of downswings as just described.
Figure 16. Completion of the trade, and buy stop order (take profit) executed at 2.5 x the risk taken in the trade.
Figure 16, above, shows the completion of the trade.
Finally, almost 15 minutes after the stop loss was trailed to 1.09316, the market takes out the take profit level, providing the soothing 2.5 x reward to the risk taken.
Completion of the trade
The take profit (buy limit) order is completed, the details logged and the profit booked.
Here is what the completed order looks like in the terminal area of the Metatrader platform, figure 16, which is the penultimate figure in this series.
Figure 17. Order number, time of order, type, volume, symbol, entry price, [most recent] stop loss, take profit, time of close, price the trade was closed at.
The astute reader will notice that there is a discrepancy as can be seen in terms of the take profit order (the buy limit at the ask price order in effect).
This required some investigation. We talked earlier of the level 1.09211 yet the trade was closed out at 1.09225. What happened?
Further investigation by way of examining the chart (and seeing the price action in real time), plus a simple call to the broker revealed the cause was slippage.
The volatility of the market, captured in some way in figure 18 below meant that even though the take profit was triggered in the right place, the best price we could get out immediately after the trigger was 1.4 pips greater than our desired take profit.
The remedy to this would have been to allowed 1-2 pips for slippage over and above the spread when calculating the risk to reward ratio.
As it happens in this trade, the market did continue down, so this would be noted in trade journaling as a point for consideration, because over 1000s of trades, that slippage is going to add up and needs to be dealt with by factoring in some kind of average slippage, or slippage factor weighted by volatility in the current market to neutralize it.
Figure 18. Volatility on the exit candle (3rd candlle from the right)
Figure Note. The long wick on the exit candle was a very quick bounce off the take profit area (marked in green), demonstrating that there was considerable profit taking or buy at market and limit orders around our take proft, to the extent we could not get an excellent fill on this trade, thus losing 1.4 pips to slippage.
On the one hand this serves to demonstrate we picked a sensible price to exit, but on this occasion so sensible that the rest of the market’s buying in the absence of sellers at that moment, created a small liquidity gap and hence gap in the price action, resulting in the slippage – the next available price to buy when the price reached our buy limit of 1.09211 was immediately 1.09226.
The broker took us out at that best possible price to buy once 1.09211 had been touched.
Summary and Conclusion
Analysis for trading journal
Final analysis: the trade was entered on the exhaustion of a Friday morning burst, with a sell limit at the retest of the MR2 (mid-resistance 2) resistance line, confluent with an H1 warning 1 (unreported). The trade was filled and a 1:2.5 risk reward trade was set up, with 7.6 pips risk. As the trade progressed and almost hit the take profit, to within less than 1 pip, the stop was moved to -1.25 x the stop loss ahead of the break even point. The trade went on to hit the -2.5 x stop loss reward area, but 1.4 pips were lost due to slippage. In the end, 7.6 pips were risked, and 17.6 pips made, for a final risk:reward ratio of 1:2.316.
In conclusion, using a sell or buy limit order is a more sophisticated way to manage the entry of a trade, allowing the trader to have greater control over the parameters of a trade, in advance of the pricing reaching the desired level of entry. The same goes for sell or buy stop orders, which are covered in the stop order article.
About the author
Dr Samuel Alexander Beatson gained his PhD from the Research Centre for Banking & Finance at the University of Nottingham in 2015. He has taught financial markets analysis for more than ten years, including during a two year position at King’s College London, as a researcher and fellow at the Lau China Institute. He is the head of trading and market analytics at Quantisi Ltd.
Freddy FastTrack’s FastTrackForex.com quote of the day
Everything is planned out in advance, so that we can let the market come to us, and let the trade take care of itself.
Top 3 Trading Moments from this trade
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