Orders and Order Properties: The Building Blocks of Trading (Chapter 4)
Every trade starts with an order. And if you don’t understand orders, you’re basically showing up to a poker game without knowing the rules. Chapter 4 of Larry Harris’s “Trading and Exchanges” is all about orders, what they are, and the properties that make each type useful (or dangerous) in different situations.
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What Is an Order, Anyway?
An order is just a set of instructions. It tells brokers and exchanges what you want to trade, whether you’re buying or selling, how much, and on what terms. If you can’t personally sit at the trading desk negotiating every deal, you need orders to represent your interests.
Here’s the thing: your order submission strategy is the single most important factor in whether you succeed as a trader. The right order at the right time can mean the difference between a great trade, a terrible one, or no trade at all.
The Language of Trading
Before we get into the order types, there’s some vocabulary you need to know.
When traders want to buy, they make bids. When they want to sell, they make offers (also called asks). The highest bid in the market is the best bid. The lowest offer is the best offer. Together, they form the BBO (Best Bid and Offer). The gap between them is the bid/ask spread, and it’s basically the price you pay to trade.
When someone’s order gives other traders the ability to trade, that order offers liquidity. When someone grabs that opportunity, they take liquidity. This distinction between offering and taking liquidity is fundamental to understanding how markets work.
Market Orders: Speed Over Price
A market order says: “Trade right now at whatever the best available price is.” It’s the order you use when you care more about getting the trade done than getting a perfect price.
Small market orders usually fill immediately at the best available price. But there’s a catch. Market orders pay the bid/ask spread. If you buy at the ask and immediately sell at the bid, you lose the spread. That spread, or really half of it, is the cost of trading immediately.
For large market orders, the problem gets worse. When you try to buy a huge quantity, you might exhaust all the sellers at the best price and need to start buying from sellers at higher prices. This is called market impact. The bigger your order, the more you move the price against yourself. Harris gives a great example of someone buying 400 orange juice futures contracts and pushing the price up by 0.90 cents just to get the full order filled.
Sometimes you get lucky and receive price improvement, where a dealer or specialist fills your order at a better price than the current best quote. But you can’t count on it.
The bottom line with market orders: you know you’ll trade, but you don’t know exactly what price you’ll get. There’s execution price uncertainty.
Limit Orders: Price Control at a Cost
A limit order flips the trade-off. It says: “I’ll trade, but only at this price or better.” If you’re buying, your limit price is the maximum you’ll pay. If you’re selling, it’s the minimum you’ll accept.
If nobody wants to trade at your price, your order just sits there in the limit order book, waiting. It might fill later, or it might expire without ever trading.
Here’s one of the most important insights in the whole book: standing limit orders are free trading options that you give to the market. When you post a limit buy order, you’re essentially writing a put option. Anyone can “exercise” it by selling to you at your price. When you post a limit sell order, you’re writing a call option.
And just like regular options, these limit order options have value that depends on three things: the limit price, how long the order will stand, and price volatility. In volatile markets, your limit order is more valuable to other traders because there’s a bigger chance the price will move in a way that makes exercising your order profitable for them. That’s why bid/ask spreads tend to widen when markets get choppy.
So what do you get in return for giving away these free options? You hope to get a better price. Buyers who use limit orders hope to buy at the bid instead of the ask. Sellers hope to sell at the ask instead of the bid. But sometimes the market moves away from your order, and you end up having to chase the price and pay even more than you would have with a market order.
Two big risks with limit orders: execution uncertainty (your order might never fill) and ex post regret (your order fills, then the price blows right through it and you wish it hadn’t). Adverse selection risk, where the people who trade with you tend to know more than you do, is the key driver of that regret.
Stop Orders: The Safety Net
A stop order stays dormant until the price hits a specified stop price. Then it activates and becomes a regular order (usually a market order).
The most common use is the stop loss order. You buy cotton futures at 80 cents, then set a stop sell at 70 cents. If cotton drops to 70, your broker tries to sell immediately. But here’s a subtlety people miss: the execution price might be way worse than 70 cents if the market is falling fast.
Stop orders look like limit orders because both have price conditions, but they serve opposite purposes. A limit sell at 5 euros activates when the price rises to 5. A stop sell at 5 euros activates when the price falls to 5. Different directions, different logic.
One important market effect: stop orders can destabilize prices. When prices drop, stop sell orders trigger and add more selling pressure. When prices rise, stop buy orders trigger and add more buying pressure. They add momentum to moves, which is the opposite of what contrarian traders (who use regular limit orders) do.
Other Order Types Worth Knowing
Market-if-touched orders are the opposite of stop orders. They activate when the price moves favorably. You want to buy if the price drops to a certain level, so you set a touch price. Unlike limit orders, once triggered they become market orders so you’re sure to trade.
Tick-sensitive orders care about the direction of the last price change. A buy downtick order only fills when the price ticks down. These essentially function as limit orders with dynamically adjusting prices.
Market-not-held orders give your broker discretion. You’re saying “fill this, but I won’t blame you if you wait for a better price and it doesn’t work out.” Brokers love these for large orders because they can carefully manage exposure without being held accountable if the market moves away.
Validity and Other Instructions
Orders come with various conditions:
- Day orders expire at market close
- Good-till-cancel (GTC) orders stay open until you cancel them (don’t forget about these)
- Immediate-or-cancel (IOC) orders fill what they can right now, cancel the rest
- All-or-none orders must fill completely or not at all
- Iceberg orders (also called hidden or reserve orders) only display part of their true size
That last one is really clever. If you want to sell 90,000 shares but don’t want to scare the market, you show only 10,000 at a time. As each chunk fills, more gets revealed. Other traders can try to discover the hidden size by submitting large fill-or-kill orders.
The Big Picture
Orders differ along two key dimensions: uncertainty and liquidity. Market orders give you certainty of execution but uncertainty about price. Limit orders give you price certainty but uncertainty about whether you’ll trade at all.
Market orders demand liquidity. Limit orders supply it. Understanding this dynamic is the foundation for understanding how markets work, why spreads exist, and why some traders consistently profit while others consistently lose.
The order you choose is a strategic decision. Get it right, and you save money. Get it wrong, and you pay for it. That’s the game.
This post is part of a series on Larry Harris’s “Trading and Exchanges: Market Microstructure for Practitioners” (Oxford University Press, 2003). Chapter 4 covers orders and order properties.