Different order types are among the most boring stock market subjects, mostly the focus of a small sect of high-frequency trading enthusiasts and opponents.
But the discussion of stock market orders shouldn’t be about the orders themselves, but framed in a discussion about trade planning.
Planning your trades has a significant material effect on your P&L. In the qualitative sense, you’re preemptively hedging about potential emotional trading.
In other words, when you plan both your profit target and stop-loss orders at the same time as your trade entry, you don’t have to worry about watching a big red candlestick and feeling paralyzed and terrified to book a loss.
You’re also protecting against human error.
Have you ever tried to exit a trade by pressing your hotkey, only to realize that you hit the wrong hotkey, or didn’t have your platform window selected, or a slew of other potential errors?
There’s substantial evidence from several sources that using stop-loss orders improves your trade’s expected value in the quantitative sense.
For instance, algorithmic trading data from Reddit user Tacoslim on the AlgoTrading subreddit found that the use of stop-loss orders improved his Sharpe ratio, reduced average loss, improved returns, and dramatically reduced the portfolio’s largest loss.
So, to the subject at hand: bracket orders.
Bracket orders are basically lists of instructions that you send to your broker. On that list is your primary trade entry, coupled with some contingencies.
In plain English, a bracket order might look like this:
- Buy 100 shares of XYZ, limit @ $45.00
- If XYZ < $42, sell all shares
- If XYZ > $50, sell 50% of position
- If XYZ > $60, sell 100% of position
Pretty basic, right?
You enter all of your planned orders at once so you can walk away and let your broker handle things should your trade reach an exit point.
Basic brokers like Robinhood probably only allow very basic bracket orders, while more advanced brokers like Interactive Brokers enable you to get much more creative with your bracket orders.
Some additional details you might include in your bracket order might be:
- Which exchange to route your order to
- Order type: Limit, stop, market-on-close, etc.
- How long each order is in effect for: day, good-til-canceled, fill-or-kill, etc.
In general, bracket orders are best used for swing trading or day trades lasting hours.
Skilled higher-frequency day traders are better off observing the market structure develop in real-time and reacting accordingly with their hotkeys.
However, it never hurts to have a last-resort stop loss in place.
Example of a Stock Market Bracket Order
Let’s take a hypothetical trading scenario and create a bracket order for the entry.
Below is a chart of PTGX. After an earnings gap up, the stock has settled into a range between $15 and $19. Perhaps we’ve decided to wait for an upside breakout in the stock and buy the breakout.
Suppose we want to set a profit target around $22 (a previous high) to sell 50% of the position, and a stop loss at around $17.23, which is two times the average true range subtracted from our entry price of roughly $19.15.
This trade is for demonstrative purposes; it was one of the first charts in my watchlists.
- The entry order is in white
- The 50% profit target is in green.
- The stop loss is in red
Types of Bracket Orders
Trading-focused brokers like Interactive Brokers or Lightspeed Trading offer clients many options by which to structure their trades.
Here are some examples of orders you can include in a bracket at advanced brokers:
- Contingency Orders: An example would be “If SPY crosses above the 20-day SMA, short oil,” or “if XYZ hits $10, buy the XYZ $12 June 30 call option.”
- Market-on-Close Orders: these orders execute at the closing auction, which is the time of day with the most liquidity. Their market orders which receive the “closing print.” Traders who enter positions early in the day and want to exit on the closing print may utilize these in a bracket.
- Trailing Stops: stop-loss orders that automatically trail the price as it moves up.
As you can see, you can automate away many of the externalities which you might usually closely watch for in a swing trade.
When Not To Use Bracket Orders
Many hotkey-loving day traders are much more skilled at trading in and out of the market with their keyboard than setting up a bracket order and walking away.
Proprietary traders in specific, who typically use obscure and unscalable day trading techniques, are unlikely to use a bracket order in many of their trades.
In low-liquidity, low-float momentum stocks, especially, you’re highly likely to be stopped out of the trade purely as a result of volatility and not necessarily the trade going bad.
Many day traders of these stocks don’t rely on binary stop loss and take profit levels, but instead, observe how the market reacts to trading at critical levels on level 2.
If your trading plan is relatively simple, chances are you can create a bracket order which encompasses your entry and exit plans, including trailing stops and selling portions of your trade as it succeeds.
New traders are probably best off using bracket orders for all of their trades.
When you commit to concrete entry and exit levels before entering a trade, you don’t have to worry about how you’ll react when you’re in a losing trade that just broke through a critical support level.
Because novice traders don’t have the intuition or discipline to execute on the fly, bracket orders can save them from blowing up.