Crypto Trade Execution: What Type of Trader are You?

This is part 3 of a 6-part series on Markets. Markets Series: Part 1, Part 2

Crypto Trade Execution: What type of trader are you?

Welcome back to The Market Series. The topic of execution touches on how traders evaluate, strategize, and place orders on the exchange to maximize their profits and minimize losses. 

Price vs. Execution Risk

A trader faces two types of risk when submitting an order:

  • Price risk — the risk that your order may move the market price and result in a trade at an unfavorable price. Price risk is also referred to as slippage.
  • Execution risk — the risk that your order will not execute entirely, or at all, because the price you are advertising may not match with another trader. 

Everyone has different sensitivities when it comes to price and execution risk. If you’re determined to win an auction no matter what, you might choose to pay a higher, Buy-it-Now price. In this case, you’re said to have low sensitivity to price risk, but high sensitivity to execution risk. Conversely, that toothpaste you ordered online doesn’t need to arrive tomorrow for an extra $5 shipping fee. Here, you are said to have high sensitivity to price risk and low sensitivity to execution risk.

Notice, though, that price risk and execution risk are really just a set of tradeoffs. Traders that want to execute a transaction right now often need to sacrifice their price sensitivity, and traders who want to manage their price risk carefully must give up their sensitivity to execution risk. Traders accomplish this through order types.

Order Types

We’ve previously described an order as a set of instructions. These instructions indicate basic information like whether you’d like to buy or sell an asset and for what price. An order type represents a pre-configured instruction form that allows traders to include additional criteria tailored to manage their execution risk.

Kraken offers four order types: Market, Limit, Stop Loss, and Take Profit. Below we will cover the first two basic order types and provide some context on the primary motivations for using each one.

Market Orders

Order Instruction Description
Asset & Market

Buy or Sell

Quantity

Market orders immediately match with available orders advertised in the orderbook. These orders carry the highest price risk, as they will take at any price posted on the orderbook. For this same reason, they incur the lowest execution risk. Traders use market orders to nearly guarantee* that they will execute their trade.

*Market orders may not fully execute if the market order is for a quantity larger than all of the combined, advertised orders in the orderbook, an unlikely event.

Limit Orders

Order Instruction Description
Asset & Market

Buy or Sell

Quantity

Limit orders require a trader to designate a limit price. For buy orders, this is the highest price the trader is willing to pay; for sell orders, this is the lowest price the trader is willing to accept. Limit orders carry lower price risk because traders can explicitly choose their price. However, they have higher execution risk as the order may not be marketable, or immediately matched with bids and asks in the orderbook. For example, a trader placing a limit order to buy bitcoin for $500 per bitcoin while the market value is $10,000 per bitcoin will have to wait for a significant decrease in market prices before their buy order is executed.

However, intuitively, as limit orders designate a price, it can also be placed such that execution risk is low to none. For example, if a trader placed a limit order to buy bitcoin for $10,000 per bitcoin when the orderbook ask volume is heavily filled at $10,000, it is likely to be matched immediately. This shows that limits orders can carry low execution risk, if desired.

 

Stop-Loss and Take-Profit Orders

Order Instruction Description
Asset & Market

Buy or Sell

Quantity

Stop Loss Price

A stop loss order allows a trader to designate a stop loss price that triggers a sale when the market price crosses a chosen threshold.

Traders use stop loss orders to limit their potential losses from a certain position. Because stop losses triggers a market order, this trade carries a higher price risk (because you cannot be guaranteed a specific sale price) and lower execution risk (because you know that trade will be settled). 

Order Instruction Description
Asset & Market

Buy or Sell

Quantity

Take Profit Price

A take profit order allows a trader to designate a take profit price that triggers a market order when the market price exceeds a chosen threshold.

Traders often use take profit orders to lock in profits by placing a market sell order if prices rise to the trigger level. Since take profits also trigger a market order, this trade carries a high price risk and low execution risk. Take profit orders also execute as taker transactions.

Next time… 

We’ve now covered the basics on markets, orderbooks, trading, and execution! These topics represent the foundational elements to market structure. First, we conceptualized markets and described orderbooks as a forum for traders to advertise bids and asks. Then we defined a trade as a confirmed exchange between a buyer and a seller that have agreed on a price. Here, we discussed how traders consider the process of execution in their trading decisions. In our next post, we’ll build off of these concepts and discuss liquidity and market impact, so that we can get into more advanced topics and thorough market structure analysis. Stay tuned!