Anticipating market orders – the concept is very simple and easy to understand yet most traders do not contemplate it nearly enough, especially when they want something to happen and nothing is happening. Experienced traders may find this blog a bit elementary but there are many new traders who don’t fully comprehend this concept and many experienced traders who frequently forget it.
I discuss this topic in more depth in my course material but I’ll offer a simple explanation here in order to help new traders get the idea.
Let’s say you and I are the only two participants in the market. I am working a limit bid at a price of 5 and you are working a limit offer at a price of 6. If we both just sit there staring at each other and neither of us is willing to change our price, nothing happens. In order for price to change, one of us has to be willing to trade at a different price. Either I have to use a market order and buy at 6 or you have to use a market order and sell at 5.
A sustained move in one direction occurs because traders keep using market orders to buy at higher prices or sell at lower prices. If I buy at 6, I only get paid if someone else is willing to buy at 7 and higher. So before I buy at 6, I have to ask myself, “What’s the likelihood of market orders buying at 7, 8 and 9?” Another way of asking the same question would be, “Who is going to hit the next price?”
If the pace of activity is fast and furious and it’s obvious that trades are being executed by hundreds or thousands of people and the markets are in full game-on mode…and prices are ripping to new highs on heavy volume…then it makes sense that more market orders will continue hitting even higher prices as people try to join the party on the long side and shorts get squeezed…so taking a long trade might be justified.
If a market has barely moved in the last thirty minutes and a couple orders hit the highest price of the day…and the pace is extremely slow…and it’s obvious that very few people are involved…then it makes sense that not many market orders are going to immediately be buying at higher prices because chances are no one needs to do anything . In this scenario, I’m anticipating very few or even zero market orders hitting higher prices so there’s no reason to take a long trade. I am more interested in going short in this situation as it’s likely sell orders will eventually start hitting bids once everyone figures out buyers have stopped buying at the highs and no one seems to be using market buy orders to attack limit sell orders anymore.
During busy periods, people often want concrete confirmation that they are right before they execute the trade. This isn’t possible because by the time the confirmation is there, you’ve missed the trade.
If you see a breakout to new highs and it’s a situation you’ve seen prior and you know, statistically, market orders usually keep hitting limit sell orders and driving prices to new highs in this type of scenario, you have to take the trade as the breakout is happening and not after it’s happened. If you wait too long, you are the person buying the high of the day. Everyone else bought sooner because they were anticipating you buying at a higher price and when you finally buy, they are selling to you.
So…before executing a trade, always assess the scenario and ask yourself how likely it is that, in the current situation, market orders will keep driving price in one direction during a short period of time. If it appears you are the only person interested in buying or selling and it’s obvious not much is happening, best to close the platform and take a break for awhile. Otherwise, you will find that you are constantly hitting the worst prices and asking yourself the age old question, “Why does it always go when I’m not in and never go when I am?”