bid ask spread
Futures Order Entry Methods
Sometimes it is the small details that make a big difference in futures trading performance. Familiarity with commodity order types and how to properly place each of them, is critical to being a successful trader. Commodity market prices and dynamics are ever-changing, making every second count. Regardless of whether you are trading online via a futures trading platform, or through a commodity broker, knowing the type of order you need to place and placing it accurately is vital.
Communication is the key. If you have questions about the different types of futures orders and how to place them verbally or online, call your broker for assistance. Futures contracts are highly leveraged trading instruments; accordingly, mistakes in order execution are costly! Throughout my lengthy career, I’ve managed to rack up a handful of gut wrenching trade placement errors; some of them well into the thousands of dollars. It is imperative that traders take the steps necessary to keep such errors to a minimum.
Futures Market Bid/Ask Spread
Before discussing order types in the futures market, it is imperative to understand the nature of commodity prices. For any given futures contract, there are essentially two commodity quotes. There is a price at which it is possible to immediately buy the futures contract, and there is a price in which a commodity trader could immediately sell. The price at which traders can buy the futures contract is known as the ask; the price traders can sell a futures contract is known as the bid. The difference between these prices is referred to as the bid/ask spread.
In most futures markets, the bid/ask spread is minimal, but those commodity markets that lack ample trading volume can involve rather wide spreads between the bid and ask. In such markets, order slippage and transaction costs will be much higher than that of a sufficiently liquid futures market. Further, even in some liquid commodity markets, there are certain futures contract expiration months that have less volume than others. For instance, if you are interested in trading the e-mini S&P 500 the front month contract is highly liquid but attempting to trade contracts with expirations several months into the future will likely be inefficient due to a lack of market liquidity. For example, the bid/ask spread of the front month e-mini S&P futures contract is generally 1 tick, or .25 points (equivalent to $12.50) but the bid/ask spread on a contract expiring a year down the road is generally 10 to 12 points, or $500 to $600). In other words, along with the stated commission charged by your commodity broker to enter the trade, the cost of executing in the distant expiring futures contract is several hundred dollars as opposed to $12.50 for the front month.
Those new to trading in commodities, often overlook the hidden cost of the bid/ask spread built into the commodity markets, and all other markets for that matter. Some attempt to buy or sell futures contracts with distant expirations to avoid the commission cost associated with rolling positions over (exiting an expiring futures contract to enter the next contract month to avoid delivery of the underlying commodity); ironically, their quest to save a few dollars in commission can easily cost them hundreds of dollars in unsightly transaction costs such as the bid/ask spread.
You might hear some aged (or perhaps, seasoned is a better word) traders refer to the ask price of a futures contract as the “offer”. Thus, if you hear someone say “bid/offer” you can assume it is synonymous with bid/ask. In addition, if you hear a trader say “the market is offered at” it is equivalent to saying “it is possible to buy the commodity at”.
This is the most common futures order type simply because it is the most convenient. A market order initiates the futures trade at the current market value by filling the order at the best possible price at that particular time. This means that you will be taking the bid price if you are selling the commodity contract, and taking the ask price if you are buying it. Keep in mind that a market order guarantees that your order will be filled but it doesn't guarantee that you will be happy with the price.
This futures order type initiates the trade at a specific price "or better" if possible. “Or better” is the key here. If the order is to buy a futures contract, “better” is equivalent to a lower price; if the order is to sell a futures contract, “better” is equivalent to a higher price. For example, entering an order to buy 1 August Soybean futures contract at $11.05 means the trader will only accept being long from $11.05 or less. In essence, traders use market orders if they prefer to get filled over receiving a certain price; if the priority is to receive a particular price, or better, a limit order should be used.
Seasoned traders know the market might hit the limit order price without the trade necessarily being executed. This is because of the bid/ask spread, and the fact that limit orders are filled on a first come, first serve basis. If there are 100 traders working a futures limit order at the same price, the earliest orders to be filled are those that put their order in first. Further, if the market peaks or troughs at the limit price not all 100 orders typically get filled because there might not be enough traders willing to take the other side of the trade at that price.
Accordingly, a limit order is only guaranteed a fill if the futures contract price trades at least 1 tick beyond the limit order price. For this reason, it is often said in the business that it "has to go through it to do it".
Simply put, if you have an order to sell the mini-sized Dow at 17,250 and that price is the high of the day, your order may, or may not, have been filled; but if the high of the day is 17,251 you are owed a fill.
Stop Order (AKA Stop Loss)
This order becomes a market order only when the specified price level is reached. This can mean that the futures market trades at the stop price, or the stop price has become part of the bid/ask spread. A commodity buy stop order is placed above the current futures market price, and a sell stop is placed below the current futures market price. In any case, a stop loss order is subject to the possibility of slippage on the fill. In other words, your fill price may be different that the stop price that you had originally named.
Fill slippage occurs because the stop loss order becomes a market order, it is not an “or better” order. Futures stop loss orders are most commonly used to “stop the loss” of a speculative position gone bad. For instance, a trader long December Corn futures from $5.00 might place a sell stop order at $4.80 to liquidate the position should the market go against the original speculation by 20 cents. Once again, slippage is possible. Simply placing a stop loss order at $4.80 doesn’t guarantee a fill at that price. The reported fill might be $4.79, or much lower depending on market conditions, volatility, and potential price gaps from the market closing price in one session to the opening price of the next. Nevertheless, in today’s electronic markets slippage is typically minor.
A stop loss order can also be used to enter a commodity market. If a trader believes a futures market might continue to rally once it breaks technical resistance, he could place a buy stop order to enter the market with a long position if prices rally to your stated price. To illustrate, if crude oil futures are trading at $62.00 per barrel, and you believe a break above $63.00 could open the door for a large rally, it might make sense to place a buy stop at $63.10. This order would execute a long futures contract for the trader if $63.10 is reached. If the commodity price never reaches the stop loss level of $63.10 the order will not be filled.
Trailing Stop Loss
Some, but not all, futures trading platforms and futures brokers offer the ability to enter trailing stop loss orders. This order type initiates a stop loss order which moves incrementally with favorable futures market movement. The parameters of the trailing stop loss order depend on the platform, and the discretion of the trader, but it typically involves some sort of measurement of tick price movement. For example, a trader that is short a futures contract might place a buy stop above the market to protect from losses. If the trader chooses to use a trailing stop loss order, he might instruct the platform to lower the stop by 5 ticks for every 5 ticks the futures price falls. Once the stop loss order is placed, or trailed, it will not back up; thus, if the stop order is trailed twice before the market reverses, it will be triggered at the last trailing stop price (which is 10 ticks lower than the original stop loss price).
One Cancels the Other (OCO)
This is also referred to as a contingency order because it requires that the commodity broker, or futures trading platform, cancel one of your orders should the other be filled. Not all futures brokers are willing to accept this type of order becuase of the risk of something going wrong (whether it be technical error, human error, or simply a fast moving futures market). For example, a trader long December Corn might simultaneously place a limit order above the market as a profit objective, and place a stop loss order beneath the market to limit the exposure to risk of an adverse futures price movement. If these are placed together as an OCO, execution of one of these orders would result in the cancellation of the other. As previously mentioned, if you place this order through your futures broker, he is taking on a substantial amount of responsibility with this type of order and will likely only do so on a full service basis. However, most trading platforms are capable of accepting this commodity order type for electronic execution. As a result, there isn’t nearly as much human intervention involved in OCO orders than was once the case.
The ease and access of OCO orders has greatly improved the convenience of trading commodity futures. Prior to advances in technology in the commodity industry, mis-executed OCO orders created a lot of chaos. Imagine the stress of being long or short a futures contract because the un-filled half of an OCO order wasn’t properly canceled, but was later inadvertently filled.
MIT (Market If Touched)
This order is similar to a stop order in that it becomes a market order once the specified price is "touched". However, it is also similar to a limit order because a sell order is placed above the current futures market price and a buy order is placed beneath the current price. In other words, this is a special type of limit order. Rather than the trader asking for a price or better, the trader simply wants to be filled at the best possible price should the market hit their stated MIT price. A market if touched order in a commodity market avoids the frustration of a limit order hitting the stated price, but going unfilled. However, it also opens the door for some slippage in the fill price.
MOO (Market on Open)
The market on open order type was born in the trading pits. Originally, it was an instruction to buy or sell a commodity futures contract on the open of the pit trading session. However, electronically executed futures markets have really changed the landscape of this type of trading because speculators are now able to place futures orders around the clock. There is no longer a morning “open”, or at least not an official one. Instead, most commodities open for trade in the afternoon prior to the day the trading session closes. To clarify, the futures markets open on Sunday night, and trade through Monday afternoon. On Monday afternoon, they close for a brief period (an hour or two for most futures contracts), then open back up for trading. The Monday afternoon re-open is considered Tuesday’s trading session.
Because of this change in logistics and timing, MOO orders have mostly dropped off most futures trading platforms. However, some trading platforms offer “timed” orders in which commodity traders can establish an order to buy or sell a futures contract using a market order at a time just after the open of trade, or at the time in day in which the open outcry trading pit previously opened when it was in operation.
MOC (Market on Close)
A market on close order is one in which the trader wishes to buy or sell a futures contract at the close of a trading session. Similar to the market on open designated order type, the MOC order is far less common in an electronic trading world but some platforms are capable of imitating the order type through “timed orders” which are released by the platform at a time of the day specified by the trader entering the futures order.
TAS (Trade at Settlement)
The trade at settlement (TAS) order type is essentially the new MOC order for the futures markets. A TAS order is placed by traders who wish to buy or a sell a commodity futures contract at the settlement price of the current trading session. A Trade at Settlement order is unique relative to the Market on Close because it gives futures traders the opportunity to name the acceptable fill slippage. This is necessary because it might not be possible to fill all of the TAS orders at the actual settlement price. Don’t forget, for every buyer of a futures contract there is a seller; therefore, in order for a TAS order to be filled at the settlement price of a commodity, another trader must be willing to take the other side of the trade at that price. Accordingly, TAS orders can be placed at 0, +1, or +2 (or at -1, or -2) to designate the number of ticks above or below the settlement price the trader is willing to accept as a fill price.
The reference to iceberg stems from the idea that the “tip of the iceberg” is the only visible part of a large mass of ice emerging from a body of water. Accordingly, the term “Iceberg Order” is defined as the practice of breaking an order to buy or sell a large quantity of contracts into multiple smaller orders through the use of automated software. As the futures markets moved from open outcry execution to electronic, this order type has become increasingly more popular. This is because those traders, whether retail or commercial, trading large quantities typically prefer to mask the true volume from view of others. In other words, iceberg orders enable the “public” to see only a small portion of the actual order at a time.
Most futures trading platforms offer the ability to view DOM (Depth of Market) data in which it is possible to observe the working buy limit and sell limit orders of other traders. These working orders on display are often referred to as the “book”. Some traders monitor the trading book for large quantity orders. In theory, large buy orders indicate the market might be inclined to move higher, or at least it suggests that a large player, or players, believes it will. These inferences, whether right or wrong, can influence prices and possibly prevent the entity placing the large quantity to be filled at their desired price. As a result, funds and institutions placing sizable orders have incentive to mask the true quantity of their order. Simply put, those using iceberg orders do so under the belief that it will reduce the impact the order has on price movement as it is absorbed into the market.
When an iceberg order is placed, the trader determines the disclosed volume which will be placed as a regular limit order, and the hidden volume which is only placed once the first tranche is filled. For most retail traders, iceberg orders are not necessary but the ability to execute them is available on most futures trading platforms, so it is a good idea to understand what they are. However, it is typically not a good idea for average retail traders to use this order type. After all, those trading small quantities will have little or no impact on prices so there is no need to disguise the quantity. Furthermore, because the hidden quantity is only placed after the disclosed quantity, it will fall to the bottom of the priority list in the exchanges trade matching system. In other words, traders unnecessarily using iceberg orders are reducing their odds of getting filled at their limit price.
GTC (Good 'Til Canceled)
As the name implies, good ‘til canceled orders, often called open orders, are always considered active until filled, canceled, or replaced by another order. Beginning futures traders have been known to place GTC orders and forget about them only to find that disaster has struck while they weren't watching. If you are gong to use GTC orders make sure that you properly monitor them. Most platforms and commodity brokers assume futures orders are “day orders”, meaning they are canceled at the end of the trading session if they aren’t executed. Consequently, when entering futures orders intended to be active until otherwise canceled, it is necessary to convey it as such.
Straight Cancel (Straight "Can")
This completely eliminates a previously placed order. Keep in mind, a futures “market” order cannot be canceled because it will be filled immediately.
This cancels and replaces a previous order by changing the price, type, or quantity, but you cannot replace the commodity or contract month. Depending on the futures trading platform being used, it might or might not be possible to modify a working order into a GTC (Good ‘Til Canceled) order designation.
In most commodity futures markets it is possible to cancel/replace a working stop loss or limit order into a market order, but futures contracts traded on the ICE exchange (Intercontinental Exchange), typically cannot be modified into a market order. In this instance, it is necessary to cancel the existing order outright, and enter a brand new futures order ticket to buy or sell the futures contract at the market price.