OCO Order: a Chance or a Trap?
It's not easy to define where the market will move in the future. Sometimes, it seems the chance of a bullish and bearish direction is equal. What should a trader do? Simply leave the market and stay without anything? It's not the best option. That's why the one-cancels-the-other order was invented.
OCO Order: The Core Concept
There are different types of orders. You may know pending orders, market orders, stop loss, and take profit orders. In general, an order is a command to a trading platform to do the specific steps when certain conditions are met.
Talking about the meaning of the OCO order, an OCO order or one-cancels-the-other order is a pair of pending orders, one of which is canceled as soon as the other is executed. Usually, an OCO order is a combination of stop and limit orders. It’s executed automatically when the price touches the levels that the trader set.
One-cancels-the-other order is a pair of pending orders, one of which is canceled as soon as the other is executed.
The OCO order is used to minimize risk trading in a highly volatile market. When a trader can’t predict the upcoming market direction, it’s worth placing two opposite orders, one of which will work and another which will be deleted simultaneously.
There is also an order-sends-order command. However, it works in the opposite way. It triggers but does not cancel the second order. This is a significant point.
Although we are talking about the OCO order, we should remind you what pending orders are as they are the basics of the OCO order. Look at the picture below.
Pending orders are the basics of the OCO order.
Stop orders are presented by buy stop and sell stop orders. By placing them, a trader expects the price to break at a predetermined level so that the trade will be open.
Limit orders consist of buy and sell limit orders. A trader anticipates the price to rebound from a certain level.
OCO Order: the Process
As we mentioned above, the OCO order helps investors reduce risks. Let's imagine you have shares of a company. As the stock market is highly volatile, especially in times of meaningful news or economic releases, the investor can place an OCO order.
Assume the stocks have a price of $100. Due to the volatility, you anticipate the price can decline, but you don't want to lose more than $15. You place a sell stop order at $85. This means that if the price slips to $85, the stock will be sold at this level. However, if the price surges to $115, the sell limit order will be triggered. It means your stock will be sold at $115.
You should remember two significant points. The first one is that if one order is executed, the other one is canceled. The second is that if one of the orders is canceled, the second one is deleted as well.
The OCO order is usually set when the market is highly volatile. Otherwise, a trader will have to wait for a long time before any of the orders work. At the same time, it's a huge pitfall of this type of order. Some brokers had to block OCO orders as they increased the size of loss because of the lack of a specific stop loss.
The OCO order usually occurs when the market is highly volatile. However, high volatility is also a pitfall of this instrument.
We will explain with an example. Imagine the market is highly volatile. You placed a buy stop order, expecting the market to rise; and a sell stop order, considering a change of a downtrend or even a buy limit order considering a rebound strategy.
However, after the buy stop order was triggered, the market reversion occurred. You know that pending orders allow you to open positions without monitoring the market. It means you could miss that moment when the market moves in the opposite direction. As there is no stop loss with either of them or it's too far from the entry point, you will lose your funds.
High volatility may be a reason for the following situation: the market may reach the stop loss but later move in the same direction again. It means you will suffer losses even though your market prediction was correct.
It doesn't mean you shouldn't use the OCO order; you just need to be pretty sure the market will form a trend and won't turn around until it reaches a specific point.