Order Types - 2: combine orders for profitable trading

Hi everyone. Welcome to this second video on order types. So today we are going to see how we can combine the different type of orders that we have seen in the previous video and also what we should do and we should not do when you are combining these orders. So as usual, please have a look at the disclaimer and now we can proceed. So we are going to analyze five situations that we can find when we want to buy or sell. So the first one is when we want to simply buy. And this is also called sometimes going long. The second one is we want to buy but we want to use also a stop loss. And a stop loss is basically a way to define the risk of the trade we are going to take. The third one is when we want to buy with a stop loss, but also we want to impose a target profit. In other words, stop loss is telling us that at this price, I want to sell to cut my losses. The target profit is the level where we are going to sell to take profit. And of course if the stop loss is triggered, then the target profit should be cancelled, right? And if the target profit is hit, then the stop loss should be cancelled. So that's why this type of order is called bracket oco, where OCO means order cancels order. You can also go short or sell in the market and I will explain later what it means. But as you see, short selling without a stop loss is not really something that we should consider and we will see later. That is a very risky strategy to short sell without a stop loss. So in this case, the only two available options are shorting with a stop loss or again with the OCO bracket order. So let's consider the first situation. We just want to buy some shares of a stock, right? And to do that we can use the orders that we have seen in the first video. So we have the market order where we are buying at the ask price. If you remember, we have the stop order, the limit or the stop limit. And usually in this case these orders are daily order, right? So okay, the market order will be filled immediately. The other orders you can place good deal, cancel or daily depends on your strategy. And this is usually used for buy and hold or dollar cost averaging approaches. So those strategies are usually long term strategies where you buy and you keep for years, maybe five, 10 years. And it only works when you are really confident that what you are buying will increase in price in the long term. So let me show you for example how the dollar cost averaging strategy works. So this strategy requires you to specify an amount of Money, let's say thousand dollars that you want to invest every, let's say three months, six months, you decide. Okay, so so let's say that you want to buy. Something, maybe the S&P 500 or something else. And let's say that this is the price, okay? And here we have the time. Okay, so let's say that the first interval is here, the second one is here and the third one is here. And I don't know, fourth one is here. Okay, so let's say that this one is after the first six months I want to buy and I will buy at this price. And suppose that this price is $100. Okay, so how many shares do I buy here? Well, I want to invest $1,000. The price is 100, so I will buy thousand over 100. That is 10 shares. So here I buy 10. What if the price is going up? Okay, well actually here, let's say this is after other six months, the price is again at $100. So again I buy 10 shares. And suppose that here, the third time period, the price is $200. Okay, so how many shares do I buy here? Well, in this case again I invest thousand, but now the price is 200, so I buy 5 shares. Okay? And suppose that here the price is 250. So again after other 6 months I buy and since the price is 250, this time I buy 4 shares. So as you can see, the idea of this strategy is when the price is low, I buy more, and when the price is higher, I buy less. And if the price in the long term is going up, the average price you are paying is actually quite good. Okay, so this is the dollar cost averaging strategy. Now in this strategy you don't have a stop loss, okay? Because if the price is dropping, actually you buy even more. And with the buy and hold is a similar strategy, right? You buy and even if there is a big drop in price, you hold. Because the assumption at the base of the strategy is that the price eventually will go up. What is the issue here? Well, the risk is not controlled. As I said, if there is a big drop in price, you should not sell. Okay, let's see the second one. Okay, this is a strategy where we want to buy, but we want to have a stop loss. And again, as before, to buy we can use a market order, a stop, a limit or a stop limit. And usually this is a day order. But for the stop loss, first we need to have a good deal cancel order because we need to be sure that our protection is Always there and to a stop loss, we should use the stop or the trailing stop order, but we should not use for example, a stop limit. And let's see with an example how this works. First thing is which order to use when I want to buy. Well, it actually depends for some strategies. For example, there is one called breakout break out. What happens is that you see, let's say this is $10. The price keeps hitting some level, okay? And the idea is that when the price is actually breaking out this level, that is called resistance, usually there is a very strong momentum and the price, especially as the volume is increasing, will go up a lot or sometimes what happens is that after breaking out, there may be a small retracement and then it will go up. So in this situation, suppose that you see your price approaching this resistance level. What you can see is you can submit a stop order. Because the stop order will basically say if the price is going above 10, then I will buy, right? So if you put a stop order here and the price is going above, then the stop order will be triggered and you will buy here, right? So in this case, for example, a limit order should not be used, but a stop limit order can be used. And actually, my favorite order is the stop limit. And I will show you why. Now, when we buy with a stop loss, let's say we want to buy at $10, okay? And let's say we put a stop loss at 9. So the idea is that if we buy at 10 and then the price is dropping to 9, theoretically what I am risking in this trade is $1 for each share that I buy, right? Now, if this order to buy at 10 is a stop order, actually I have no idea what will be the filling price. It can be 10, it can be 11, it depends, right? So actually I have really no idea about the real risk I'm taking. I know that it should be around $1, but actually it can be 1.5 and, and this can be really something that makes a difference if you are buying a lot of shares. So with a stop limit order, suppose you have a stop limit, That is $10 stop and 10.5 dollars limit. I know that I expect on average to buy something between 10 and 10.5. So if I know that I buy from 10 to 10.5, I know that in the best case my risk is I buy at 10, stop loss at 9, so it's $1, okay? If I buy at 10.5, my risk is $1.50. So at least I have an idea about the Range of risk that I am taking and usually what I do as like rule of thumb is to take the middle point, so in this case 1025 and then estimate my risk per trade using this middle point. So in this case it will be 125. Okay? Then of course when the order is triggered, only then you will see what is the real risk you took. But at least with the stop limit you can have a better idea. Now I was saying that if you buy and you have a stop loss, the stop loss should not be a stop limit order. It can be a stop order, it can be a trailing stop, but not a stop limit. Why? Because remember the stop order, the way it works is that when the price is going down, right and hitting your stop, then there will be a sell market order executed. Right? Now suppose that you put a stop limit. So you say okay, as a stop loss, I want to have a stop limit where the stop is 9 and the limit is 8.5. Okay, so what is the meaning of that? Suppose you buy at 10 and then you say okay, the price is going down and hitting nine. I want to sell, but I don't want to sell at a price that is lower than 8.5. And by doing so you may think that you are limiting your loss. But actually there is a big issue here. Suppose that the price is going down so fast that by the time this is triggered, you are already below the limit. Or maybe there is a gap. So what happens in this case? Well, your order will not be triggered because the stop is triggered. But if the price is already below the limit, you will not sell. So if this one keep falling, you will never sell, so you will lose much more. Okay, now you can say well, to avoid this, I can just lower my limit price, right? So what if I put it at eight? Well, if you put it at eight, of course is safer, but it's not safe because again you may have some event where the price is jumping below this level, right? So there is a person I know when I was also asking this question, I remember the reply was I think it's a nice metaphor is using a stop limit as a stop loss is like using a condom with a hole. And lowering the limit price is like having a smaller hole and hoping that everything will be fine. But you know, I will not risk to do that. So again, when you want to use a stop loss, please use a stop order or a trailing stop. Don't use a stop limit. Okay, so next we have the order cancel order bracket. So actually here we are Combining two orders, so the stop loss and the target profit. And as I said before, when one is executed, the other one is cancelled. So again you have an order, the main one, the buy order, that can be one of the four types we have seen. Stop loss as before, profit target is a sell limit order. So let's see again with an example. Suppose you buy, you want to buy something stock, the usual stock X. And let's say you have buy stop limit, okay? $10, 10:30. So at this time you should know that $10 is a stop and 10:30 is the limit. And you want to attach a stop loss at 8:50. So this means that if the order is triggered when the price is hitting 8.5, I will sell with a market order. But this time I also want to attach the target. And so the profit, right? I want to sell maybe at 14. It means that if the price is going to 14, I want to sell to take profit. And this should be a limit order. Why? Because remember when you are selling, okay, the sell limit order means I want to sell at this price or better. So I want to sell at 14 or higher. So in other words, you are saying I want to have at least a profit of 14. But if there is a gap up and I sell at 15, well, even better, right? So with this strategy, if your order is triggered, then you have only two options. Either the price is going down, hitting 8.5, this will be triggered. And this one, the limit order will be cancelled. Or the price is going up hitting your target profit and this stop loss will be cancelled. So this is the order cancel order bracket. Okay? And again, remember that for the stop loss and the profit target, it's better to use the good till cancel option. Because we never know when the stop loss or the profit target will be hit. Okay, so what about short selling? I don't know if you are familiar with short selling. So let me just give you an example to explain what short selling means. So suppose you are walking with your friend, okay? And your friend has two bottles of water. And when you are walking, you find a very thirsty guy who is willing to pay you $10 for a bottle of water. So what can you do? Well, you can borrow the one bottle of water from your friend and you can sell it to your to this thirsty guy and collect the $10. Then later, suppose you are still walking and then you find a supermarket and you see exactly the same bottle of water for $1. So what do you do? You enter the supermarket, you buy the water for $1 and you give it back to your friend. So by doing so you gain $10 from the thirsty guy. Then you buy the water to give it back to your friend and you spend $1. So you make a profit of $9. Short selling is similar. You borrow some shares from your broker to sell them and you hope that the price is going down. And at this point, when the price is lower, you can buy back the share to give them back to the broker. And you make the difference as profit. Of course there are commission fees and borrowing fees. So it's not as simple as the example with the water. But more or less the logic is the same. Now, why you should not short sell without a stop loss. Well, the reason is simple. When you are going long, you are buying. There is a maximum amount of money that you can lose. And this is equivalent to the position size, right? So suppose you buy 100 shares trading at. Actually we can write this. Suppose you go long, okay? So you buy hundred shares at a price of $8. So your position is $800. Okay? Now what is the worst case scenario? Okay, you can have your stop loss, whatever you want. But really the worst case scenario is when the price is going to zero, right? So bankrupt of the company. What happens in this case that your loss, the maximum loss you can have is the position, right? So $800. But what about the profit? Well, the profit there is no limit. If this guy is going to $80. So increasing 10 times, then you make your position is now 10 times more. So it's 8,000, right? And if the price keep increasing, there is no limit. Well, when you short, you are selling, remember at a high price, let's say again a share. So your position now is. 800. Okay? It means that you borrow shares from your broker and you sold. So you receive 800. But you have to buy back. Now if the 8 as before is going to zero, what happens? Well, in this case you don't buy back the shares. So in other words, you keep the 800. And this is the worst, the best case. But what if the price is going to 80, right? What if the price is actually going to 80? So if the price is going to 80 and you want to buy back now, hundred shares. Are worth 8,000. So you gain 800. But you have to buy back the shares at 8,000. So your loss will be $7,200. And if this one is going to, I don't know, hundred, then this is worth 10,000. So your loss will be nine. Sorry, 9200. So as you can See, since there is not a limit in the price that the stock can reach, and since when you are shorting, you lose money, when the stock price is going up, you have unlimited risk. You may lose even more than your capital. So when you are going short, you should be very careful. You should have some protection. It can be stop loss, it can be something else, like having a call option. But you need to have something because theoretically the risk is unlimited. So what we can do, we can short sell with a stop loss. So it works exactly the same. The only difference is that now the stop loss will be buy, right? Stop or trailing Stop is a buy order because you sold when you open the position and then to close the position you have to buy back. And as general rule, I suggest you don't short sell illiquid stocks. So stocks with very low volume, because it will be very hard to get your order fill at the price you want. Or you can have the situation where the stop loss is trigger. And then when you execute your market order, it will be executed at a price that is quite far from your stop loss. Do not short penny stocks. So stocks for example in the US market that are trading at, you know, below, I don't know, $5, $2, because they can be easily manipulated. So they can move really a lot. Do not short pharma companies, these are also very, very volatile. For example, when there is a result concerning approval for some drugs, they can move along. And also don't short when you are near events, for example, earning announcement, that can create a lot of volatility or gap. And again, the reason is the price can move a lot. And with a short position price moving a lot, if it's moving in the wrong direction that in this case is going up, you may end up losing much more than what you expected. And there is not really a limit. Okay, so what about the sell short with OCO bracket? Okay, as before, but the stop loss and profit target are buy orders. So for example, you may want to have a, let's say going short on stock X. And for example, you want to execute a stop limit order. Okay, sell stop limit order, let's say at 10.5, 10. So you want to sell at 10.5 or less, but not less than 10. So again, what is the stop and what is the limit here? This is the stop and this is the limit. Okay, what is the target profit? Well, the target profit now is below the entry price. So for example, the target, remember is a limit, maybe $8. So means I want to buy back if the price is going there and that will make the difference. And a stop loss in this case that can be a stop or a trailing stop. Maybe you can put, I don't know, $11. Okay, so means if the price is going up against what I predicted, then I want to buy back when it's hitting 11. Okay? So as you see is exactly the same as the buy, just that the target this time is below, the stop is above and the logic is the same. So just to summarize, we have seen how we can buy and sell and how we can combine the orders that we have seen in the previous video. Something that you should do, unless you are really using a buy and hold approach or a dollar cost averaging and you are really, really confident that in the long term the price will go up is always use a stop loss to control your risk. And the stop loss should be a stop order, should be a trailing stop, but it should not be a stop limit. So remember the metaphor with the condo. And the other thing you should remember is stop loss and target profit should be good till cancel orders. Because you always want to have your protection there, the stop loss. And if you want to have a profit, of course you want it to be there as well. You don't want to miss your target. For example, the price was going up, the target profit was cancelled and then is going down again. And you will lose the opportunity, right? What you should not do first is to short sell without protection. We have seen why, right? The risk is unlimited. And also we have seen what you should not short sell in which situations like the volatile company, the illiquid stocks and right before some earning announcement, right? And the bottom line is this, don't place an order if you are not really 100% confident about how it works. Because it's better to lose an opportunity than money. And the thing is, when you are placing an order, it may be very easy at the beginning to be confused. Maybe you want to place a stop limit and then you get confused and you swap the limit with the stop. Or maybe you forget to place the good deal cancel for the stop loss. So you know the price is going down. You think that it will be sold automatically and then when you look into your broker account, you you see that the price keeps going down and your stop loss is not there because it was a daily stop loss, so it was cancelled. But with some practice and paper trading after a while this will be quite easy to execute. So in the next video we are going to see how we can in practice insert these orders. And we are going to use two platforms, the Tinkers Win platform and the Interactive Broker Trader Workstation. So thank you for watching. If you like this video, please subscribe to this channel and see you next time.