Orders are the primary way that a trader interacts with an exchange. To open or close a position, you will need to place orders. A position represents your exposure to a crypto asset. A long position means that you have a positive exposure to a crypto asset (betting the price goes up). A short position means you have a negative exposure to a crypto asset (betting the price goes down). The two most common types of orders are limit orders and market orders. However, there are many different types of orders and order parameters. To trade effectively, a trader needs to understand how these orders work and their limitation. In this educational piece, we will look at the different order types, the order book, standard fee structures, and some typical use cases.
The two most common order types are market and limit orders. These are the basic building block of any order-based exchange.
A limit order is an order to buy or sell at a specified price and amount. It will execute only at a price that is equal to or better than that specified price. Let us use the BTC Perpetual as an example. Let us say that you place an order to buy 10,000 quantity of BTC Perpetual at $10,000. Even though you can be filled (you get what you "ordered") for a price lower than $10,000, you will not buy the BTC perpetual higher than your specified price. Unfortunately, the limit order does not guarantee full fills and execution. If the prevailing market price is $20,000, you will not get a fill at all. Your order to buy 10,000 will join the order book and will wait for the prevailing market prices drop. We will talk more in depth about the order book in the next section.
The opposite holds true for a sell order. If you place a 10,000 order to sell at $10,000, you can only be filled at prices higher than or equal to $10,000.
A market order is an order to buy or sell at an unspecified price but for a specified amount. It will execute and match orders in the order book until the specified amount is filled. While you are almost always guaranteed a fill (barring lack of book liquidity or margin issues), each subsequent match or fill will be at a slightly worst price. These fills at a slightly worse price are known as slippage. Obviously, if you are putting in a large market order, your slippage can be substantial (and you will get your full fill with a worse price on average).
Now that we have a basic idea of the two main order types, we know enough to examine how the limit order book works (and how it applies to trades). Every trader should have a basic idea of how the order book works and what the numbers mean.
The limit order book represents all the active limit orders. We learned previously that a limit order does not guarantee fills. What happens to an unfilled order? Well, the order enters the order book and waits for market orders (or matching limit orders). If there is a market order to sell of sufficient size that eventually hits the limit order, then that limit order will be filled. We will look at a simple orderbook example.
Limit Order Book
In this example, we see that a trader (or a group of traders) has put up to 10,000 size in limit orders to sell at $9,300. Because the highest price the market currently is willing to buy (limit) is $9,000, this order was not filled. As a result, their order(s) entered the limit order book waiting for either a market order or a large limit order with price greater than or equal to $9,300 to enter the book.
Continuing, we see that there are 5,000 of orders to sell at $9,200 and 1,000 of orders to sell at $9,100. On the buy side, we see that there are 2,000 of orders waiting to buy at $9,000, 3,000 of orders waiting to buy at $8,900, and 5,000 of orders to buy at $8,000. Note that in the order book, the best price that traders are willing to buy at is $9,000, and the best price they are willing to sell at is $9,100. These two prices are known as the bid and the ask, respectively.
Now, returning to our market and limit orders. How do they work against this order book?
Combining the order book with what we learned earlier about the market and limit orders, we can see what happens when we place a market order. Let us assume that we place an order to sell 4,000. What happens? The first 4,000 will match against the 2,000 orders to buy at $9,000. You would get a 2,000 fill at $9,000. Then, the remaining 2,000 size will get a fill against the 3,000 to buy at $8,900. The resulting order book will then look like:
Market Order Example
All the $9,000 order is filled (so the size is 0). Then, 2,000 of the $8,900 buy orders is filled, resulting in a 1,000 remaining size. The new bid-ask is $8,900 and $9,100.
Now, let us look at what happens with a limit order against the same original book. Let us place a sell order of 6,000 size at a price of $8,800. What happens? In this case, we will only match against orders with a price greater than or equal to $8,800. We match all the $9,000 and $8,900 orders with 1,000 quantity left. However, because our limit price is $8,800, we do not match against the $8,000 order. The remaining sell order enters the order book as a limit sell order of price $8,800 and size 1,000. The resulting book looks like:
Limit Order Example
All the $9,000 and $8,900 buy orders are filled, with only the $8,000 order remaining. The remaining size of the $8,800 order is added to the sell side of the order book. The resulting bid-ask is $8,000 and $8,800.
Now that we have a good idea of how market orders, limit orders, and the order book works, we can look at order fees and more advanced order options.
Most exchanges will have different fees for takers and makers. Typically, the maker fees are lower than taker fees. Depending on exchange, these fees can even be negative. Drixx, for example, gives a slight rebate to makers. What does it mean to be a maker or a taker?
In general, all market order are completely taker orders (since you will be matching against orders in the book regardless of price). That means your entire size is charged the taker fee. For limit orders, you are charged only a taker fee if you match against orders in the book. In our limit order example just above, because 4,000 matched against orders in the book, we are charged a taker fee on that 4,000 in size. However, the 1,000 size sell at $8,800 is not charged a taker fee. In fact, if another order matches against it, only the maker fee is charged.
While the limit order might seem superior (after fees) to the market order, keep in mind that there is no guarantee of a fill. That means if you put in an order to buy the BTC perpetual and the price goes up, you will not have any BTC exposure. Instead, you might have to move your limit price up to get exposure. Doing that might be worse than just using the market order in the first place!
While limit and market orders make up the bulk of orders, there are many other types of orders that build off or these. We will go over some of the more common ones below
Stop Market Order -- A stop market order (or sometimes just known as a stop loss order) is a triggered market order. The order is not triggered until some condition is met. When it triggers, it becomes a market order and fills against the book.
A stop loss order is in the opposite direction of your current position. For example, if you have a current position of long 10,000 BTC perpetual, the stop-loss order will be an order to market-sell if the price drops to a certain level. If you have a 10,000 stop order to sell at stop price of $8,000 and the mark price drops to $8,000 or below, a market order is placed to sell 10,000 size. Your resulting position is then 0.
A stop order is typically used to manage risk. When you have a stop order, it means that your maximum loss is somewhat constrained to your P&L at the stop price (not including additional slippage and fees).
Stop Limit Order -- A stop limit order is like the stop market order. However, the triggered order becomes a limit order, instead of a market order.
If you have a 10,000 stop order to sell at stop price of $8,000 with a limit price of $7,900, and the mark price of the derivative drops to $8,000, a limit order is placed to sell 10,000 size at $7,900.
While a stop limit order is also used to manage risk, there is no guarantee of a fill. If the price continues to drop after hitting your stop price, you might not be able to exit. However, in a highly volatile market where the slippage might be high, a stop limit order might work better than a stop market order.
Take Profit Order -- A take profit order is like a stop market order. However, the trigger price is in the direction of your position. For example, for a long position, the trigger price will be above the current market price. In a short position, the trigger price should be lower.
The take profit order is used to take profits. If you have a 10,000 BTC perpetual long position and the current price is $10,000, you can set a take profit sell order for 10,000 size at $20,000. This order becomes a market sell order if the mark price is equal to or above $20,000.
What is the difference between this order and a simple limit order? A simple limit order does not guarantee a full fill. Even if the market hits the price of $20,000, you might only get a partial fill.
Take Profit Limit Order -- A take profit limit order is like a stop limit order. However, the trigger price is in the direction of the position (like the take profit order above).
Post Only Limit Order -- The post-only option only applies to limit orders. When you select the post-only option, it means that you only want to be a maker (and not take liquidity at all). If this order would match an order already in the book, the order is rejected. The limit price must then be between (or equal to depending on direction) the bid and ask prices.
Reduce-Only Order -- The reduce-only option is an option that you can use on a market or limit order. This means that it will only execute (or be placed) if it will end up reducing your margin.
Understanding how orders work is crucial for any aspiring trader. Different orders can not only be used to gain exposure to a crypto asset, but also to manage risk and take profits. An understanding of the order book is also important, since it can be used to gauge potential slippage.