June 30, 2020
How to use One-Cancels-the-Other (OCO) orders?
There are many different order types that investors can use to meet their trading preferences. Most exchanges offer Market and limit orders which are fairly easy to comprehend. A market order takes the best available price
What is an OCO order?
OCO stands for ‘One Cancels the Other’. It’s an order type alongside Limit, Market, Stop Loss, and others. It’s typically offered by most exchanges to traders to add utility to their trading position.
How do OCO orders work?
When an OCO order is placed, two stop orders are placed at the same time. A stop buy would be above the current market price and a stop sell would be below the current market price, typically at the boundaries of the current price range. During trading, when one of the two orders is reached, that order is executed just like a normal limit order would be. At the same time, the other order is automatically canceled. The automatic cancellation is important as this avoids unintended consequences from the order executing.
When should you use this conditional order?
OCO’s are typically used before important news and announcements such as economic data or profit projections. Especially when that news controversial, which some speculators expecting the news to interpreted positively and other speculators predicted the news to be interpreted negatively. An example of such news would be employment figures or output projections during the Covid-19 pandemic. This controversial news is expected to increase volatility because the result isn’t properly priced in by the market.
Examples of using an OCO order
Here’s an example of an OCO order used properly:
The Pear corporation that makes smartphones is entering turbulent times with poor production figures in the last quarter and possibly worse numbers this quarter ahead of the numbers being released at the end of the week. On the other hand, the economy, on the whole, has been performing well and smartphone sales, on the whole, have been rumored to have dramatically increased. With the upcoming uncertain news, investors are divided on whether the market price will rise or fall. Pear stock has been trading consistently within a set range between $1000 and $900 for a few weeks now.
Assuming they take an agnostic approach to news that’s about to come out, a trader can take advantage of this and place an OCO order, putting the stop buy at $1020 and the stop sell at $882. This would then require a 2% breakout from the range in order to trigger either of the orders. Friday comes and the news is unveiled. It turns out that despite many predictions, pears production figures are very positive and far above even the most optimistic predictions. This causes the price to start spiking. When it reaches $1020, the stop buy is triggered. At the same time, the $882 is canceled so that there’s no chance of selling the stock, without taking out another order. The stock continues to rise and then settles at $1050 having exceeded the range by 5%.