Trading Mechanics

Overview

This chapter covers how trades actually execute — the order types available, what happens when you submit an order, and the hidden costs that affect your strategy’s profitability.

Order Types

Market Order

A market order executes immediately at the best available price. You’re guaranteed a fill but not a price.

# Pseudocode: Market order
order = {
    "side": "buy",
    "type": "market",
    "symbol": "AAPL",
    "qty": 100
}
# Executes at current best ask price

When to use: When you need immediate execution and the spread is tight.

Risk: In fast-moving or illiquid markets, you may get filled at a worse price than expected (slippage).

Limit Order

A limit order specifies the maximum price you’ll pay (buy) or minimum price you’ll accept (sell). It only executes at your price or better.

# Buy limit: only fill at $150 or below
order = {
    "side": "buy",
    "type": "limit",
    "symbol": "AAPL",
    "qty": 100,
    "limit_price": 150.00
}

When to use: When price control matters more than execution speed.

Risk: The order may never fill if the market doesn’t reach your price.

Stop Order

A stop order becomes a market order when the price reaches a specified trigger level. Used primarily for risk management.

# Stop loss: sell if price drops to $145
order = {
    "side": "sell",
    "type": "stop",
    "symbol": "AAPL",
    "qty": 100,
    "stop_price": 145.00
}

When to use: To limit losses on an existing position.

Risk: In a gap down (price jumps past your stop), execution price may be significantly worse than your stop price.

Stop-Limit Order

A stop-limit order combines stop and limit orders. When the stop price is triggered, a limit order is placed instead of a market order.

# Stop-limit: trigger at $145, limit at $144.50
order = {
    "side": "sell",
    "type": "stop_limit",
    "symbol": "AAPL",
    "qty": 100,
    "stop_price": 145.00,
    "limit_price": 144.50
}

When to use: When you want downside protection but also price control.

Risk: If the price gaps below both your stop and limit prices, the order won’t fill at all — you’re left holding the position.

Order Type Comparison

Order Type Price Control Execution Guarantee Best For
Market None Yes Immediate execution
Limit Full No Price-sensitive entries
Stop None (after trigger) Yes (after trigger) Stop losses
Stop-Limit Full (after trigger) No Controlled stop losses

Execution Mechanics

What Happens When You Submit an Order 

sequenceDiagram
    participant T as Your System
    participant B as Broker
    participant E as Exchange
    T->>B: Submit order
    B->>B: Validate (margin, limits)
    B->>E: Route order
    E->>E: Match against order book
    E->>B: Fill confirmation
    B->>T: Execution report
  1. Submission: Your code sends an order to the broker’s API
  2. Validation: The broker checks account balance, margin, and risk limits
  3. Routing: The broker routes the order to an exchange or market maker
  4. Matching: The exchange’s matching engine finds a counterparty
  5. Confirmation: Fill details are sent back through the broker to your system

Time in Force

Orders can have different lifespans:

Time in Force Meaning
DAY Expires at market close if unfilled
GTC Good Till Cancelled — stays open indefinitely
IOC Immediate or Cancel — fill what you can, cancel the rest
FOK Fill or Kill — fill entirely or cancel entirely

Trading Costs

Commissions

Most retail brokers now offer commission-free trading for US equities and ETFs. However, some still charge:

  • Per-share: $0.005/share (common for institutional/API brokers)
  • Per-trade: Flat fee per order (less common now)
  • Crypto: 0.1%–0.5% maker/taker fees

Even with “free” commissions, you’re still paying costs through the spread and potential slippage. These are often larger than commissions for small orders.

Slippage

Slippage is the difference between the expected execution price and the actual execution price.

# Slippage example
expected_price = 150.00  # Price when signal generated
actual_price = 150.03    # Price when order filled
slippage = actual_price - expected_price  # $0.03 per share

# On 1000 shares:
total_slippage = slippage * 1000  # $30

Slippage is caused by:

  • Market movement between signal and execution
  • Order book depth — large orders consume multiple price levels
  • Latency — delay between decision and order reaching the exchange

Always model slippage in your backtests. A strategy that looks profitable with zero slippage may lose money with realistic slippage of $0.01–$0.05 per share.

Spread Cost

Every round trip (buy then sell) costs you at least the spread:

# Spread cost on a round trip
buy_price = 150.03   # Buy at the ask
sell_price = 150.02   # Sell at the bid
spread_cost = buy_price - sell_price  # $0.01 per share

# For 1000 shares traded 100 times:
total_spread_cost = 0.01 * 1000 * 100  # $1,000

Market Impact

Large orders can move the market against you. If you’re buying 50,000 shares but only 1,200 are available at the best ask, your order walks up the book:

Before your order:          Your 50,000 share buy fills:
Ask $150.03 × 1,200    →   Filled 1,200 @ $150.03
Ask $150.04 × 500      →   Filled 500   @ $150.04
Ask $150.05 × 200      →   Filled 200   @ $150.05
                            ... continues up the book

Market impact is primarily a concern for large accounts. For accounts under $100K trading liquid stocks, market impact is negligible.

Summary

  • Market orders guarantee execution; limit orders guarantee price
  • Stop orders protect against losses but may slip in fast markets
  • Trading costs = commissions + spread + slippage + market impact
  • Always model realistic trading costs in backtests
  • For liquid instruments (SPY, AAPL), costs are minimal; for illiquid stocks, they can destroy a strategy

Next Steps

Next, we’ll learn the financial metrics used to measure trading performance — returns, volatility, Sharpe ratio, and more.