Limit and Market orders, cognitive & behavioral review
We assume a spot market for this article purely on the result of TRADES' interaction with no market making effect from the broker or exchange. You can only profit from buying at a lower price and selling at a higher price. So, there is no short in here. And we assume that you already know the basics of market and limit orders. As you can see the table on the chart for the whole idea, we want to talk a bit deeper.
Limit Orders
Market Orders
Now for both of these order types we have Buyers and Sellers.
Buyers always want to buy at lower price, and sellers always want to sell at higher price, so every limit buy should be lower than the current price and every limit sell should be higher than the current price.
If you put a buy limit order higher than the current price or a sell limit order lower than the current price, it will act as a TAKER order not a maker order.
If there is a buy market order at the same time with another sell market order, the buy market order is filled with the lowest sell limit order on the order book and the sell market order is filled with the highest buy limit order on the order book.
So, in every trade that is executed on the order book, one of the buyers or the sellers should be a market order and the other one should be a limit order. It's either the buyer is maker, and the seller is taker, or the buyer is taker, and the seller is maker. That's how the price moves!
Selling market orders push the price to go lower and buying market orders push the price to move higher.
Selling limit orders pull the price from going higher and buying limit orders pull the price from going lower.
Selling limit orders are more spread above the resistances BUT buying limit orders are more concrete at the support price.
Now let's talk about a few facts from Behavioral Finance!
1- Confirmation Bias
: the tendency to interpret new evidence as confirmation of one's existing beliefs or theories (like when the price is inside the ichimoku cloud). So, if I buy at any price, till a long time I will think that it will go higher! and this may be why a lot of people have big losses over time and do not commit to their stop loss.
2- Loss aversion or Prospect Theory: the tendency to prefer avoiding losses to acquiring equivalent gains. losses are twice as powerful, psychologically, as gains (like the urge feeling for revenge trading when you have lost in your last trade). This may be why people use Market orders for exiting from a position instead of Limit orders.
A graph of perceived value of gain or loss vs. strict numerical value of gain or loss.
3- Risk aversion: a preference for a sure outcome over a gamble with higher or equal expected value (like when you can enter at a better price but you rather to confirm your analysis sacrificing your potential profit). This may be why people (or maybe it is better to say good traders) use Limit Orders for entering at a position instead of market orders.
Now if someone buys at a high price and gets in loss, there is a conflict between Confirmation Bias and Loss aversion. If confirmation bias wins (which is for most of the people with lower experience), you just stay in the loss in the hope of a pivot point to sell at break even and that creates an additional sell pressure on a price point near resistance which was seen before (something like Double TOP pattern). But if Loss aversion wins, you commit to your stop loss and get out faster which creates a selling pressure force in a price point under the main support areas which is the result of triggering domino like stop losses.
I try to explain few different concepts together in a structured way. I would be glad to hear your opinion.
Limit Orders
- Limit Order is like a Wall, it makes liquidity on the order book to fill the market orders and that is why it is called MAKER.
- In limit order, the price is more important than the time.
- Limit order makes the market less volatile.
Market Orders
- Market Order is like a Wrecking Ball, it takes liquidity from the order book and is filled from limit orders and that is why it is called TAKER.
- In market order, the time is more important than the price.
- Market order makes the market more volatile.
Now for both of these order types we have Buyers and Sellers.
Buyers always want to buy at lower price, and sellers always want to sell at higher price, so every limit buy should be lower than the current price and every limit sell should be higher than the current price.
If you put a buy limit order higher than the current price or a sell limit order lower than the current price, it will act as a TAKER order not a maker order.
If there is a buy market order at the same time with another sell market order, the buy market order is filled with the lowest sell limit order on the order book and the sell market order is filled with the highest buy limit order on the order book.
So, in every trade that is executed on the order book, one of the buyers or the sellers should be a market order and the other one should be a limit order. It's either the buyer is maker, and the seller is taker, or the buyer is taker, and the seller is maker. That's how the price moves!
Selling market orders push the price to go lower and buying market orders push the price to move higher.
Selling limit orders pull the price from going higher and buying limit orders pull the price from going lower.
Selling limit orders are more spread above the resistances BUT buying limit orders are more concrete at the support price.
Now let's talk about a few facts from Behavioral Finance!
1- Confirmation Bias
: the tendency to interpret new evidence as confirmation of one's existing beliefs or theories (like when the price is inside the ichimoku cloud). So, if I buy at any price, till a long time I will think that it will go higher! and this may be why a lot of people have big losses over time and do not commit to their stop loss.
2- Loss aversion or Prospect Theory: the tendency to prefer avoiding losses to acquiring equivalent gains. losses are twice as powerful, psychologically, as gains (like the urge feeling for revenge trading when you have lost in your last trade). This may be why people use Market orders for exiting from a position instead of Limit orders.
A graph of perceived value of gain or loss vs. strict numerical value of gain or loss.
3- Risk aversion: a preference for a sure outcome over a gamble with higher or equal expected value (like when you can enter at a better price but you rather to confirm your analysis sacrificing your potential profit). This may be why people (or maybe it is better to say good traders) use Limit Orders for entering at a position instead of market orders.
Now if someone buys at a high price and gets in loss, there is a conflict between Confirmation Bias and Loss aversion. If confirmation bias wins (which is for most of the people with lower experience), you just stay in the loss in the hope of a pivot point to sell at break even and that creates an additional sell pressure on a price point near resistance which was seen before (something like Double TOP pattern). But if Loss aversion wins, you commit to your stop loss and get out faster which creates a selling pressure force in a price point under the main support areas which is the result of triggering domino like stop losses.
I try to explain few different concepts together in a structured way. I would be glad to hear your opinion.
nfa & dyor
Invest Smart!
Invest Smart!
