The terms limit orders and market orders are used quite often in trading. But there is more. The list of types of orders also includes Bracket Orders. Are you a new trader and want to know more about it? Then you have come to the right place. Check out this blog to know the meaning of Bracket Orders and their related details.
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What is the meaning of Bracket Order?
A Bracket Order (BO) is a type of order used by traders to manage risk and automate their trading strategy. It’s a combination of three orders in one, namely, a target order, a stop-loss order, and an initial entry order.
The main purpose of using a Bracket Order is to establish predefined profit and loss levels around a trade, allowing traders to potentially lock in profits while minimising potential losses. Bracket Orders are particularly useful in volatile markets where price movements can be rapid and unpredictable. Such orders help traders maintain discipline by automatically executing orders based on predetermined levels. This can be particularly valuable when emotions might lead to impulsive decisions.
How does Bracket Order work?
A Bracket Order (BO) functions as a trading strategy that enables traders to proactively manage risk and optimize potential gains by establishing predefined profit and loss thresholds for their trades. This strategy involves three key components namely, an entry order, a target order, and a stop-loss order.
- Entry Order – The trader initiates the process by placing an entry order, either for buying or selling, based on their market analysis and trading strategy. This order serves as the entry point into the market at a specified price level.
- Target Order – As the trade progresses favourably and generates profits, the trader can execute a target order. This order designates a specific price at which the trader intends to exit the trade to secure their gains. Should the market reach this predefined target price, the target order is automatically activated, resulting in the trade being closed with the accumulated profits.
- Stop-Loss Order – To mitigate potential losses, the trader sets a stop-loss order. This order is triggered if the trade moves against the trader’s position and hits a predetermined price level that was established prior to the trade. Activation of the stop-loss order prompts an automatic exit from the trade, effectively capping the losses at a predetermined amount.
Let us understand how a Bracket Order is executed using the following example.
Consider a trader trading in shares of Company XYZ. The current price of one share of XYZ is Rs. 200. Here’s how a Bracket Order could work will work.
- Entry Order (Buy Order) – Place a buy order for XYZ shares at the current market price of Rs. 200. This is where you enter the trade.
- Take-Profit Order (Target Order) – Set a take-profit order at Rs. 220. This means that if the price of XYZ shares goes up to Rs. 220, a sell order will automatically execute, locking in your profit. Your potential profit would be Rs. 220 – Rs. 200 = Rs. 20 per share.
- Stop-Loss Order – Set a stop-loss order at Rs. 180. If the price of XYZ shares drops to Rs. 180, a sell order will automatically execute. This helps limit your potential losses. In this case, your potential loss would be Rs. 200 – Rs. 180 = Rs. 20 per share.
Summing it up –
- If the price goes up to Rs. 220, the take-profit order will be triggered, and you sell your shares, making a profit of Rs. 20 per share.
- If the price goes down to Rs. 180, the stop-loss order will be triggered, and you sell your shares to limit your loss to Rs. 20 per share.
Does Bracket Order work for intraday trades?
Yes, Bracket Orders are suitable for intraday trading as they enable traders to manage risk and secure profits effectively within the short time frames of intraday trading.
Can you cancel a Bracket Order?
Yes, you can typically cancel a Bracket Order before any of its component orders (entry, target, stop-loss) are triggered or executed. However, once any of these orders are executed, the associated orders will be automatically cancelled as well.
What are the mistakes to avoid while placing a Bracket Order?
Bracket Orders are used to limit the potential loss in trading and also ensure profit for the portfolio. However, there can be a few errors in executing a Bracket Order which can thereby lead to lower profits or aiming to gain superficial profits. Some of the common mistakes that need to be avoided while executing a Bracket Order are discussed below.
Inaccurate Entry Analysis
Failing to conduct a thorough market analysis before placing a Bracket Order can lead to poor entry decisions. It’s important to identify clear entry points based on technical indicators, trends, and other relevant factors. Entering a trade without a solid analysis increases the risk of starting with a disadvantageous position.
Unrealistic Profit Targets
Setting overly ambitious profit targets might result in missed opportunities. While profit targets should be attainable, they should also align with the market’s historical volatility and prevailing conditions. Unrealistic targets could cause premature trade exits and potential frustration.
Setting Tight Stop-Loss Orders
While it’s important to limit potential losses, setting stop-loss orders too close to the entry point can result in premature trade exits due to market fluctuations. Give your trades some breathing room to account for normal price fluctuations.
Ignoring News and Events
Neglecting to stay informed about upcoming news releases, economic events, or company announcements can lead to unexpected price movements. Such sudden news can impact the market and invalidate the predetermined levels of profit target or stop loss. Therefore, it is important to be aware of such events and consider adjusting the Bracket Order accordingly to accommodate them.
Differences between a limit order and a bracket order
A limit order is a type of order to buy or sell a security at a specific price or better, while a Bracket Order is a more complex strategy involving an entry order along with predefined profit-taking (target) and stop-loss levels, providing risk management and automated execution.
What are the pros and cons of Bracket Orders?
The pros and cons of Bracket Orders are highlighted below.
|Pros of Bracket Order||Cons of Bracket Order|
|Effective risk management through predefined stop-loss levels||Risk of premature exits due to tight stop-loss orders.|
|Automation of trading strategy execution||Complexity in setting multiple price levels|
|Locking in profits with preset target orders||Dependence on trading platform support and potential disruption due to technical glitches|
|Minimizes emotional interference in trading and encourages disciplined trading decisions||Limited adaptability to rapidly changing market conditions|
|Time-saving for managing multiple trades||Risk of slippage during high volatility or low liquidity periods|
Bracket orders require a clear understanding of the market movements to analyse them correctly and set the required targets. Traders can use various technical indicators for this purpose for better understanding and efficient analysis of the security or the market as a whole. The use of Bracket Orders in intraday trading allows traders to increase their place of trading as well as limit their losses on the overall portfolio.