Reverse Order - Introduction
Reverse order, also known as a Stop And Reverse order or simply SAR, is one of three actions futures traders take to close out their existing futures position. The other actions being to "Offset" and "Roll Forward".
To reverse a futures position simply means closing out the existing contract and then taking an equal but opposite position, effectively reversing the direction of your "bet". For instance, if you are long one futures contract and you think the underlying asset is going to go down, you could simply use the reverse order to turn the position around and become short one contract of the same futures contract instantly.
This free futures trading tutorial shall explore the usefulness of the reverse order and some of its applications.
Why Futures Reverse Order Instead Of Manually Closing And Opening New Positions?
So, what is the difference between manually offsetting your existing positions and then establishing new positions in the opposite direction? Why should there be an additional function called "Reverse Order"?
The main objective of using the "Reverse" futures order is that the closing order of the existing futures position and the opening order of the new futures position is executed SIMULTANEOUSLY so that there is no time gap in between the two orders which may result in slippage. Slippage is slight loss of profit when the stock moved in between the closing and opening orders. Using the Futures Reverse Order order ensures that chances of slippage between the two orders is minimized.
Application of the Reverse Order
Not only does the reverse order in futures trading help reduce or avoid slippage due to timing difference, it also reverses the position instantaneously which helps in trading extremely short and fast intraday price swings. Many futures day traders trade an intraday price channel and setup automatic reverse orders at the expected tops and bottoms of the channel in order to take advantage of the short price swings within the channel.
Using Automatic Reverse Orders In Futures Trading
Of course the picture above depicts only a concept. In reality, it is nearly impossible to set reverse orders so accurately ahead of time however, many futures day trading methods have been developed around this concept.
The reverse order is useful in this kind of trading because such intraday price swings can come quickly and suddenly and if the orders are not made simultaneously, the slippage could be very significant.
For longer term futures traders, you could probably set a reverse order at a price you believe to be a resistance or support level so that you can take advantage of a reversal off those levels. Of course, these are again just concepts. Actual execution will require more analysis than this.
Futures traders trading futures spreads could also set reverse orders on both legs in order to reverse the position when the price gap has reached a certain pre-determined limit. This is especially useful when trading futures contracts with pre-determinable carrying charges which set limits on how wide and narrow the price difference between two different futures contracts of the same underlying can be.
How Does A Reverse Order Work?
The Reverse Order or Stop And Reverse Order, is not an order most futures brokers offer. As such, it is typically a futures order type found in futures trading softwares which tend to be more comprehensive. A Reverse Order actually consists of two order in one; An Offset Order and an entry order in the opposite direction. When you choose to reverse an existing futures position, an offset order will be sent at the same time an entry order made in the opposite direction on the same futures contract in the same number of contracts. Hopefully the entire execution results in no slippage, which means that the final price of your last position and the entry price of your new position is the same but in reality, some bid ask spread loss is inevitable.