Adrian Reid shows how limit orders on exits can trap traders in losing positions. When a moving-average crossover generates a one-time exit signal, a limit order might never fill, leaving you stuck. Continuous exit conditions keep reissuing limit orders daily until the trade closes.
Most traders think limit orders reduce risk and slippage, and so they should be used for all systems. The trouble is in some systems they make things much, much worse, especially if you use them for exits. You can find yourself trapped with no way out of the trade. Let me give you a real example to explain how this works and what the real problem is.
In a trend following system, you're entering, you get a breakout signal, you buy next bar open, you're in the trade, then you hold the trade and then it hits your trailing stop and then you sell next bar on open. Okay. There's slippage at both ends, most likely. On the entry, you could use a limit order provided you've backtested it because you are going to miss signals. They're not going to get filled. So backtest it properly with a limit order entry, not just a market order entry, and assuming you can do it with a limit order. So you won't get into some trades. With the exit, if you have an exit that triggers a limit to sell and that limit order doesn't get filled, you are still in the trade. The backtest knows the limit order didn't get filled cuz you've coded it properly. So it's a limit exit system. The next day after that limit to sell didn't get filled, are you going to get another signal to sell at limit? That depends on how your system is coded. Let me give you a clear example. Imagine a moving average crossover system. If your sell rule is the 50-day moving average crosses below the 200-day moving average, right? The crossover generates a sell signal. You with me? If that crossover triggers a sell next bar on open at market, you're getting out the next day. No question. If that crossover triggers a sell at limit, Good for day, you may or may not get out the next day. Still with me? If the crossover triggers a limit that doesn't get filled the following day, the averages have already crossed. You're not getting another signal to trigger another limit order to get you out. So you're stuck in that trade. So if it's a discrete exit signal, like a crossover, the cross triggers the exit, which is a limit, that's very dangerous because you're going to wait for the next crossover, which could be who knows when before you get out. But if it's an inequality, which is a continuous exit signal, let's say this 50-day moving average is less than the 200-day moving average triggers a sell, then the following day you'll get a limit. And if it doesn't get filled, then the following day you'll get another one. The following day you'll get another one. Hopefully eventually you'll get, who knows what price, what will happen between now and then, but at least the system will get you out eventually.
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