4 Reasons to Use Limit Orders (Picture Edition)

One lesson that cannot be emphasized enough is the importance of using limit orders, especially when you’re looking to move in or out of thinly traded funds. While it’s true that the creation/redemption mechanism unique to ETFs provides liquidity, it is by no means guaranteed to be efficient. Limit orders are instructions to your broker not to process a given trade unless the price of the security you’re buying or selling is at or better than the limit you define; with market orders on the other hand, you have less control over the trade execution since you’re left at the mercy of a fluctuating price [see also How To Lose Money Trading ETFs].

The examples highlighted below are meant to serve as rude reminders to take advantage of limit orders, especially if you’re trading low-volume ETPs given their susceptibility to rampant volatility.

EEH, which applies a momentum investing methodology to the sub-sectors of the broader S&P 500 Index, trades anywhere between 1,000 and 3,000 shares on a daily basis. In less than three months’ time during the second-half of 2013, this ETN moved from a low of $8 a share to a high of $185.66; that’s a monstrous gain of over 2,200%. Someone likely got burned on the day that it peaked, 10/21/2013, seeing as how the ETN opened at $105 a share, then soared as high as $185 a share, only to sink back down to $95 a share and ultimately close at the $96 level. The ETN lost 55% the following day and proceeded to sink back below $20 a share in the weeks following [see also The Biggest Technical Glitches on Wall Street].

With daily trading volumes rarely topping the 100 shares mark, it’s no wonder that ROLA’s trading chart looks like an incomplete etch a sketch. This ETN jumped 26% on 5/16/2014, but it wasn’t because the Russell 1000, which is the underlying index that it tracks, did anything out of the ordinary that day; instead, it’s because this ETN trades very infrequently, and when it does, volumes are quite low, leading to sizable gaps without notice. Furthermore, because ROLA is triple-leveraged, this only amplifies the volatility that is already bound to plague this low-volume ETN [see 7 Mistakes to Avoid When Trading Leveraged ETFs].

Commodity prices are volatile enough to begin with; add a low-volume ETN that is supposed to track crude oil and you’ve got a recipe for disaster. OLEM has had stretches where it won’t trade for several weeks in a row, thereby leading to a big gap whenever buyers do return as the ETN tries to play “catch up” with the underlying futures price movements. For example, OLEM gapped 4% higher between 5/16 and 5/22, then it traded sideways until gapping another 3% on 6/18. Trading commodity-linked ETPs is risky enough, and opting for a low-volume fund without utilizing a stop-loss or limit order is a surefire way to make someone else’s day after you’re left paying for an unforeseen premium [see also The 10 Worst ETF Trades of All Time].

Though not nearly as illiquid as some of the other ETPs on this list, the tin ETN, JJT, serves as another reminder why limit orders must be utilized to ensure you’re getting the best price. Aside from the choppy daily chart above, take note of the price action seen specifically on 3/6/2014; JJT soared as high as $52.94 a share, and sunk as low as $45.82 a share, resulting in more than a 15% swing in a single trading session. This sort of volatility can wipe out your gains or put you in a hole right away, depending on whether or not you make the the mistake of relying on a market order to get you in and out of JJT.

Don’t leave yourself at the mercy of the markets’ fluctuations; avoid placing market orders because that leaves a great deal of wiggle room when it comes time for the broker to execute your trade. Instead, get in the habit of using limit orders to ensure you’re getting the best price, and especially when you’re looking to trade leveraged and/or low-volume ETPs.

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Disclosure: No positions at time of writing.