Commodities - Basic Risk Management - Order Types

It's common knowledge that in trading commodities, like any other kind of speculating, there are no guarantees. You can make money, or lose money - a lot, and quickly. What's less commonly known by the average trader are the many methods professionals use to reduce the risk of loss and limit the amount.

The most basic knowledge needed is that of the different kinds of orders that can be executed: Market, Limit, Stop and their variations.

Market

Market orders are the simplest, the one with which everyone is familiar. An order is placed and the broker attempts to fill it at whatever is the going price. Even with such loose requirements, there's no guarantee the trade will get executed quickly.

When liquidity is very low, some orders may wait a considerable time, even to the next day. The commodities and futures markets, though, are huge and active. Market orders generally are filled within minutes, if not seconds.

There are several variations on market orders, including MOC (Market On Close), MOO (Market On Opening), MIT (Market If Touched) and others.

Much as the names suggest, market on opening is an order to execute at the best possible price during opening, and similarly for a market on close order, at closing.

Market If Touched orders are similar to limit orders (see below). In this case, though, orders are filled if the price is reached and continue to be filled even when the price moves away from the limit.

Limit

The next simplest type, limit orders are a request to buy or sell at a designated price. Typically, buy orders are placed below the current market price and sell orders above.

Depending on the designated price, and general market conditions, the order may not get filled. Even if the market reaches the limit price, there are thousands of trades executing every second. Yours may or may not get executed.

Stop

Stop orders, short for 'stop loss' are used to limit potential losses on a long or short position. A buy stop order is typically requested for an above market price, sell stop orders below market. Once the stop order price is reached, it becomes a market order and is executed accordingly.

There are a few variations: stop limit, stop close and others.

Stop limit orders list two prices. One price is listed just as an ordinary stop order, the second in the form of a limit price. Once the stop is reached, the limit requirement is effectively cancelled.