Trading Tip #2: Trade with a Plan – Setting Your Limits

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I think trading with a specific plan is one of the most sensible things a trader can do. It helps you learn and identify key areas to watch for in a market. More importantly, it helps you avoid sabotaging yourself because it helps keep your emotions in check. One of the key components of a trading plan is knowing your exits. One way to close an open trading position is with a limit order.

Limit orders target a specific price level – they won't be filled unless the market trades there

 

Limit orders are pretty straightforward once you get the hang of them. They are contingency orders. The market has to trade at a specified price level before it is even possible for the order to get filled. Even then, there is no guarantee that it will get filled.

 

Limit orders say that the trade can be executed at a specific price level or better, but not worse

 

Buy limit orders are used for an exit strategy on open short positions. Use these if you sold a contract to enter the market. Sell limit orders are used in a plan to exit open long positions. They are employed if you bought a contract to initiate a trade.

Basic limit orders specify the market and the price level and the action to take. For example:

Buy one December e-mini S&P futures contract at 1350.00 or better.

 

To be an effective limit order, the market would have to be trading above that price point at the time the order is placed. Why? Because if you were to put in an order like that and the market was already trading lower, it would already be a better price to buy at. That means the order would probably just be executed at the market.

The same kind of logic has to be played out when you are picking a price for a sell limit order. For example:

Sell one December e-mini S&P futures contract at 1355.00 or better.

 

For this order to work as it is intended, the market must be trading lower than the limit price, otherwise it is already at a "better" price to sell.

Limit orders are likely the "happy" exit plan for a trade. They represent better prices than the market will be trading at the time you place them. That means if you enter a market and then place an exit order at a "better" price, you are probably aiming to exit at a profit.

 

Past performance is not necessarily indicative of future results.

Chart courtesy of Gecko Software.

 

 

Once the limit order has been placed (buy limit to close an open short position, sell limit for an open long position), it is just a matter of waiting to see where the market goes. This part of a plan can help traders avoid those mental traps where they ride trades just a little too long, hoping to scoop up extra. Limit orders can prevent you from getting greedy. If you have other working orders at the same time, don't forget to cancel them if the other orders are filled.

Traders can use limit orders as part of a complete trading plan that covers the potential for the good and the bad

 

Limit orders only come into play when the market trades at or through your limit price. Otherwise, they remain in waiting. If the market trades through the price, you can only be filled at your limit price or better. It's that simple. These contingency orders can also be used to enter a market position, but I often recommend they work as part of an exit plan for trade design.

 

Best Trades to you,

 

Larry Levin

Founder & President- Trading Advantage

larry@tradingadvantage.com