Introduction to Conditional Orders

by Investing School on December 22, 2008

Last week, we explored market and limit orders and stopped when we got to conditional orders. Let’s continue our discussion today.

What Are Conditional Orders

The advance in automation technology and electronic exchanges have created a market that is highly liquid and much more volatile than before.  Conditional orders were developed as a way to trigger orders automatically if a predefined condition is met, thereby helping us manage rapid changing of events.

Originally, conditional orders were mainly used by professional traders but more and more retail investors are starting to use these type of orders to limit their risks in a highly volatile market.  The most common types of conditional orders are: stop, hidden and trailing stops, contingent, bracketed, one cancels all, one triggers all, and one triggers oco order.  Let’s look at each one in detail:

Stop and Trailing Stop Orders

A stop order basically tells the brokerage firm to sell the investment if it hits a certain price point.  For example, I can set a stop order for stock XYZ at $15 when the XYZ is priced at $16 a share.  XYZ can then move up and down but if it ever drops down to $15, the stop order will trigger a sell of the stock.

Another type of stop order is what is known as a trailing stop order.  While you set a specific price in a standard stop order for orders to be triggered, a trailing stop order changes the stop price with the movement of the stock.  For example, I can set a trailing stop order of $1 below the price of the same stock, XYZ when it was at $16.  At the beginning, the stop price would be $15.  However, as the stock moves up to $18, the stop price moves up along with the stock price to keep the “$1 below price” rule, making the new stop price $17.  Some brokerages even give investors the flexibility of using trailing stop percentages instead of a specific dollar amount, so check carefully for your options before using any of these.

Bracketed orders

Essentially, bracketed orders are two orders combined into one.  This type of order allows you to make sure you get out of your position if either the price meets the upper or lower end.  Say you I own shares of XYZ trading at $15. If I place a bracketed order with a trailing stop at $5 and a trigger at $20, I’m saying that I want to sell XYZ when it reaches $20 or if it falls to $10 ($5 below $15).

As the bottom end is a trailing stop at $5, there is one more detail to note.  If the stock rises to $18, the new stop price would become $13.  Therefore, the bracket shrinks to $13 and $20 where a sell order will be executed when the price hits either end.

Contingent Orders

Brokerages also let us place orders automatically based on different conditions.  Contingent orders can be used to place orders when a specific price for a stock, option or index is met.  For example, I can set a contingent order to buy stock XYZ whenever it reaches $20 a share.  Not only that, I can also set it up so it automatically executes orders when the Dow goes to 10,000 for instance.  This allows me to be away from my computer and still have orders executed.

One Cancels All Orders

Sometimes, we place several orders but only want one of those executed (there could be many reasons, but limited funds would be one).  For example, I only have $5,000 but want to buy either 200 shares of XYZ @ $25 or 100 shares of ABC @ $50 per share.  I can place an One Cancels All order and enter both of these orders so if either order is executed, the other will be automatically canceled.

One Triggers All Orders

Sometimes, we also want to place a few other orders whenever an order is executed.  In those cases, we would place an One Triggers All order.  Below are two scenarios where people use this type of order the most:

  1. Potentially limit the losses so a stop order is immediately placed
  2. Set a profit target by having another sell limit order placed as soon as the buy order is executed

One Triggers OCO (One Cancels Other) Orders

This type of order is an extension of the One Cancels All order.  Basically, an One Triggers OCO Order consists of an order (market or limit), and a group of One Cancels All order.  Once the first order is executed, the One Cancels All Order is activated.

Let’s use an example to help illustrate.  Imagine you place a One Triggers OCO order group made up of the following:

  • Primary order – Buy 100 shares of XYZ at a limit price of $15. ABC is trading at $16 per share at the time you place your order.
  • Order #1 of OCO group – Sell 100 shares of XYZ at $20.
  • Order #2 of OCO group – Sell 100 shares of XYZ at a stop price of $12.

If the share price ever go to $15 and your buy order is executed, the OCO group will be activated.  At this point, either order #1 (the sell order at $20) or order #2 (the stop order at $12) being executed will cancel the rest.

What Does This All Mean for Investors

Even though many of these types of orders are used by professional traders, investors have also started to take advantage of the automation and inherit discipline that using these orders help achieve.  In most cases, long term investors do not need to use any of these types of orders but it’s very important for us to learn these orders to help us when the need arises.

I truly encourage you to spend some time to re-read the explanation of these orders to make sure you understand them because using these will help keep your emotions from affecting investment decisions as orders can be placed ahead of time based on a well thoughtout plan.

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{ 1 comment… read it below or add one }

Krishna February 19, 2010 at 3:35 pm

It became clear now about OCO orders. I was searching for the explanation of these kind of orders.

Thanks a lot


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