3 Types of Exchange Orders and How they Work
Discover a few types of orders on a crypto exchange and how each are used to reach a desired result.
Buying and selling cryptocurrency on an exchange has a lot of similarities to trading stocks. Before getting into the different types of trades, it’s important to make a point about purchasing crypto that is slightly different from the rest of the orders.
If you simply sign up for Coinbase (or any similar exchange), you can make an instant purchase directly on the app. You will be given a set price for the cryptocurrency, and receive the amount stated. This is a safe and reliable way to buy cryptocurrency as the exchange acts as a market maker and guarantees you a price. However, this usually comes at an increased fee and spread for convenience and safety. This is what is called “Spot Trading”.
In addition to this method of purchasing cryptocurrency, you can also purchase cryptocurrency Peer-to-Peer. In the early days of cryptocurrency, there were very few options to purchase bitcoin. While some exchanges existed, many who purchased bitcoin did it directly peer-to-peer.
This was done both in-person and over the internet. If you wanted to purchase bitcoin in 2012, you may have had to go to a coffee shop or someone’s home, give them cash, and they would send you bitcoin in return. While this method still exists, it is much less common than in the early days as access to cryptocurrency has become significantly easier.
A market order is similar to a spot trade in some ways but has some major differences. Spot trading does not generally occur in the same way a market trade does, even though they both are ways to settle a trade very quickly. If you use a more complex trading platform such as Coinbase Advanced Trading. you will have multiple options. These include market orders, limit orders, and stop limit orders.
A market order is a more aggressive order. Instead of placing an order to buy or sell a cryptocurrency at your desired price, you place the order to execute at the market rate at the exact time of the order. There are pros and cons to this method.
The pro is mainly the speed and general guarantee the trade will execute. If for some reason you are very pressed for time, and need to make an order quickly, market orders are a good way to go.
However, because your trade will execute at whatever the market price is, you don’t have as much control over what price you pay and what quantity of cryptocurrencies you receive. In much more liquid and highly traded cryptocurrencies such as Bitcoin, market orders tend to be fine as you likely are not trading a large enough amount to seriously alter the price. However, if you are trading a cryptocurrency that is less liquid and lacking a lot of trading volume, market orders can be dangerous.
You are essentially agreeing to buy/sell a cryptocurrency at whatever the prices are currently in the order book. The issue here is that in less liquid markets, even a few hundred dollars could move the price significantly.
If the current price of a cryptocurrency is $5, but only one person has a $200 buy order for $5, if you sell more than $200 of that cryptocurrency, you will end up selling the remaining $100 for the next lowest price. The next lowest price could quite literally be $1, and in an instant, you actually lose money on the trade without realizing it.
A limit order is a safer way to trade cryptocurrency but has several cons as well. When you place a limit order, you are stating that you want to buy X amount of cryptocurrency at X price. No matter what happens to the price of that cryptocurrency, your order will execute when it hits that price. This is a significantly safer way to trade in a less liquid market, as you avoid accidental losses through a market order.
However, there are also some downsides to a limit order. There is no guarantee that your limit order will ever be filled. You can place a limit order for 10 Bitcoin at $1 per bitcoin right now. Unfortunately, this order is unlikely to execute as Bitcoin hasn’t traded for $1 in almost a decade.
While this is an extreme example, if you place an order for bitcoin at $20,000 (current bitcoin price $21,000), bitcoin has a rally and rises back to $40,000. Not only did your order fail to fill at $20,000, but you missed almost 100% profit.
Stop Limit Order
A stop limit order is essentially the same thing as a Limit order, but it is used for a specific purpose. Say you purchase bitcoin at $20,000, and bitcoin rises to $40,000. While you are thrilled you doubled your money, you are anxious about what to do. If you sell it now, you might miss out on more money.
If you hold it, it could crash back to $20,000 and erase your profit. A stop limit (often called a stop loss) order is a smart solution to this dilemma. A stop limit order is an order placed to sell your cryptocurrency at a specific price, say $30,000. This way, if Bitcoin crashes back to $20,000, you will automatically lock in the profit you made from $20,000 to $30,000, as the bitcoin will be instantly sold at $30,000.
There are some risks to stop losses, especially in less liquid markets. Large players will sometimes do what is referred to as “stop loss harvesting” where they will sell a significant amount of a cryptocurrency, crashing the price and thus triggering a significant number of stop losses. These stop loss triggers will then crash the price even more intensely.
These players will then purchase the cryptocurrencies triggered by the stop losses and the price will quickly recover to its previous price. While this is arguably not legal, there are still not adequate protections in the cryptocurrency market to prevent ethically questionable practices such as this.
Stop losses also (while uncommon) may accidentally be missed. In a situation where for some reason the price goes directly from $12 to $8 suddenly, there is a small possibility your $10 stop loss will not trigger. It is not a failsafe.
- Spot trading is convenient and secure but will cost more money to execute.
- Market orders have a very high chance of executing, but can be risky in less liquid markets and you are unable to guarantee you will get your desired outcome
- Limit orders will guarantee you get your desired outcome if the price of a cryptocurrency hits the price you set the order, but with the added risk that you may never have the trade execute at all if the price never hits.
- Stop losses are a fantastic way to manage risk and prevent losses in profits or principal investments but can be risky especially in less liquid markets. They also (while uncommon) may accidentally be missed. In a situation where for some reason the price goes directly from $12 to $8 suddenly, there is a small possibility your $10 stop loss will not trigger. It is not a failsafe
What are Futures?
Stablecoins: How Do They Work?
Altcoin Types and Real-World Use Cases
Special Announcement: Our Proudest Achievement to Date – META Strategy Soft Launch!
✍️ Head of Content @ Cindicator
📊 Certified Bitcoin Professional
🔐 Blockchain Chamber - Chapter President
Who is Cindicator?
Cindicator is a world-wide team of individuals with expertise in math, data science, quant trading, and finances, working together with one collective mind. Founded in 2015, Cindicator builds predictive analytics by merging collective intelligence and machine learning models. Stoic AI is the company’s flagship product that offers automated trading strategies for cryptocurrency investors. Join us on Telegram or Twitter to stay in touch.
Information in the article does not, nor does it purport to, constitute any form of professional investment advice, recommendation, or independent analysis.