Market Order vs. Limit Order: An Overview
Buying stock is a bit like buying a car. With a car, you can pay the dealer’s sticker price and get the car. On the other hand, you can negotiate a price and refuse to finalize the deal unless the dealer meets your valuation. The stock market works in a similar way.
A market order deals with the execution of the order. In other words, the price of the security is secondary to the speed of completing the trade. Limit orders, on the other hand, deal primarily with the price. So, if the security's value is currently resting outside of the parameters set in the limit order, the transaction does not occur.
Market Orders
When an investor places an order to buy or sell a stock, there are two fundamental execution options. The first is to place an order "at the market" or "at the market". Market orders are transactions meant to execute as quickly as possible at the current market price.
When a layperson imagines a typical stock market transaction, they think of market orders. These orders are the most basic buy and sell trades, where a broker receives a security trade order and then processes it at the current market price.
All orders are processed within present priority guidelines. Whenever a market order is placed, there is always the threat of market fluctuations occurring between the time the broker receives the order and the time the trade is executed. This is especially a concern for large orders, which take longer to fill and, if large enough, can actually move the market on their own. Sometimes the trading of individual stocks may be halted or suspended, too.
It’s also worth bearing in mind that a market order that is placed after trading hours will be filled at the market price on opening the next trading day.
Even though market orders offer a greater likelihood of a trade being executed, there is no guarantee that it will actually go through. All stock market transactions are subject to the availability of given stocks and can vary significantly based on the timing, the size of the order, and the liquidity of the stock.
Market Order Example
For example, an investor enters an order to purchase 100 shares of a company XYZ Inc. "at the market". Since the investor opts for whatever price XYZ shares are going for, the trade will be filled rather quickly at wherever the current price of that security is at. If the price per share is $10, the investor's order would be filled with securities costing $1,000.
When the order for XYZ was placed, the investor often does not know the exact price at which the shares would be purchased at. For instance, when the market order was placed, the broker might have quoted the shares at $9.80 each as this may have been the market price as the order was being prepared.
This highlights the importance of not using market orders for volatile investments. For example, consider if market order initially quoted at $5 per share. Because XYZ is a volatile investment, it is possible the investor will now need to pay much more than what the market price otherwise appear as.
Limit Orders
A second primary type of order that can be placed is set "at the limit" or "at a limit price". Limit orders set the maximum or minimum price at which you are willing to buy or sell.
Limit orders are designed to give investors more control over the buying and selling prices of their trades. Prior to placing a purchase order, a maximum acceptable purchase price amount must be selected. Minimum acceptable sales prices, meanwhile, are indicated on sales orders.
Limit orders can be of particular benefit when trading in a stock or other asset that is thinly traded, highly volatile, or has a wide bid-ask spread: the difference between the highest price a buyer is willing to pay for an asset in the market and the lowest price a seller is willing to accept. Placing a limit order puts a ceiling on the amount an investor is willing to pay.
Traders need to be aware of the effect of the bid-ask spread on limit orders. For a limit order to buy to be filled, the ask price—not just the bid price—must fall to the trader's specified price.
A limit order offers the advantage of being assured the market entry or exit point is at least as good as the specified price.
Limit Order Example
If an investor is worried about buying XYZ shares for a higher price and thinks it is possible to get them for a lower price instead, it might make sense to enter a limit order. For example, the current market price for XYZ is $9.80. An investor believes the equity will fluctuate between $9.50 and $10.10 this trading period.
In this example, the investor may place a limit order to purchase 100 shares of XYZ at $9.50 each. Because the market price is higher than the order price of $9.50, the order will not fill when it is placed.
Later in the day, the price of XYZ drops to $9.50. The limit order is filled, and the investor buys the securities for a total of $950. Because the order filled, it does not matter that the price of XYZ drops further to $9.
Last, let's imagine the shares did not drop to $9.50. Instead, the price of XYZ went from $9.80 to $11. In this example, the investor has missed out. Had they placed a market order, their order would have likely filled. Instead, they do not have any shares of XYZ because their specified price was never met.
It is common to allow limit orders to be placed outside of market hours. In these cases, the limit orders are placed into a queue for processing as soon as trading resumes.
Key Differences
Both types of orders may result in the acquisition of stock. However, each has different approaches, is set in different manners, and may result in a single share of stock being acquired at a different price.
Most often, market orders are easier to set. An investor does not need to specify their own price, whereas an investor does with a limit order. The limit order often usually has more specifications to the order such as when the order will expire. A market order does not expire as it is usually executed immediately (since the market price is the agreed-upon price).
Because a market order indicates a buyer is willing to buy the current market price, the order is almost always executed. On the other hand, a limit order is only trigger when the limit price meets the buyer specifications. If the market price does not drop far enough on a limit order, a buyer's order may not be filled.
Market Order
Easier to set up as no price is specified
Will almost always be filled as trade executes as current (market) price)
Does not have an expiration since it usually fills immediately
May be more suitable for stable investments
Limit Order
Investor must specify price at which order will trigger
May not get filled if limit order price is not met by market
Is often accompanied by an expiration date in which the order closes if not yet filled
May be more suitable for volatile, unpredictable investments
Special Considerations
The risk inherent to limit orders is that should the actual market price never fall within the limit order guidelines, the investor's order may fail to execute. Another possibility is that a target price may finally be reached, but there is not enough liquidity in the stock to fill the order when its turn comes.
A limit order may sometimes receive a partial fill or no fill at all due to its price restriction. In the example above, based on the liquidity of the shares trying to be bought, the investor may only acquire 30 shares of XYZ at their limit order price of $9.50. The rest of the order may expire if not triggered.
Limit orders are more complicated to execute than market orders and subsequently can result in higher brokerage fees. That said, for low volume stocks that are not listed on major exchanges, it may be difficult to find the actual price, making limit orders an attractive option.
A market order is simply different and more useful in some situations compared to a limit order. For long-term hold investors who may not care about tiny fluctuations in price, a market order is often an easier, less expensive option. For investors looking to lock in a specific price,
A limit is a more specific type of order that often has more features, customizations, and options. For this reason, a limit order may be assessed higher fees compared to a market order. There are many online brokerages that offer free trading (based on restrictions or limitations) that offer both limit orders and market orders for free.
A limit order is often advised for highly volatile securities. Because you do not know the price at which you will pay at the market for securities that may leap or fall in price, a limit order gives investors greater control over dictating the price at which their order closes without fear of paying or selling at a price they do not feel comfortable at.
A stop order is a special type of order designed to buy or sell a security at the market price once the market price has traded at or through a designated stop price. This type of order combines functions of both a market order and a limit order in that it only executes when a specified price is reached by the market but the security is often traded at an unknown price dictated by the market.
The Bottom Line
Investors may use two common types of orders to buy or sell stocks: market orders and limit orders. Market orders often execute right away at whatever price the market is charging. Limit orders won't trigger until the market price meets whatever price the investor wants. In some cases, limit orders won't fill because the market price may never meet the limit price specified.
With the proliferation of digital technology and the internet, many investors are opting to buy and sell stocks for themselves online instead of paying advisors large commissions to execute trades. However, before you can start buying and selling stocks, it's important to understand the different types of orders and when they are appropriate.
In this article, we'll cover the basic types of stock orders and how they complement your investing style.
Market Order vs. Limit Order
The two major types of orders that every investor should know are the market order and the limit order.
Market Orders
A market order is the most basic type of trade. It is an order to buy or sell immediately at the current price. Typically, if you are going to buy a stock, then you will pay a price at or near the posted ask. If you are going to sell a stock, you will receive a price at or near the posted bid.
One important thing to remember is that the last traded price is not necessarily the price at which the market order will be executed. In fast-moving and volatile markets, the price at which you actually execute (or fill) the trade can deviate from the last traded price. The price will remain the same only when the bid/ask price is exactly at the last traded price.
Market orders do not guarantee a price, but they do guarantee the order's immediate execution.
Market orders are popular among individual investors who want to buy or sell a stock without delay. The advantage of using market orders is that you are guaranteed to get the trade filled; in fact, it will be executed as soon as possible. Although the investor doesn't know the exact price at which the stock will be bought or sold, market orders on stocks that trade over tens of thousands of shares per day will likely be executed close to the bid/ask prices.
Limit Orders
A limit order, sometimes referred to as a pending order, allows investors to buy and sell securities at a certain price in the future. This type of order is used to execute a trade if the price reaches the pre-defined level; the order will not be filled if the price does not reach this level. In effect, a limit order sets the maximum or minimum price at which you are willing to buy or sell.
For example, if you wanted to buy a stock at $10, you could enter a limit order for this amount. This means that you would not pay one cent over $10 for that particular stock. However, it is still possible that you could buy it for less than the $10 per share specified in the order.
There are four types of limit orders:
Market and Limit Order Costs
When deciding between a market or limit order, investors should be aware of the added costs. Typically, the commissions are cheaper for market orders than for limit orders. The difference in commission can be anywhere from a couple of dollars to more than $10. For example, a $10 commission on a market order can be boosted up to $15 when you place a limit restriction on it. When you place a limit order, make sure it's worthwhile.
Let's say your broker charges $7 for a market order and $12 for a limit order. Stock XYZ is presently trading at $50 per share and you want to buy it at $49.90. By placing a market order to buy 10 shares, you pay $500 (10 shares x $50 per share) + $7 commission, which is a total of $507. By placing a limit order for 10 shares at $49.90, you would pay $499 + $12 commissions, which is a total of $511.
Even though you save a little from buying the stock at a lower price (10 shares x $0.10 = $1), you will lose it in the added costs for the order ($5), a difference of $4. Furthermore, in the case of the limit order, it is possible that the stock doesn't fall to $49.90 or less. Thus, if it continues to rise, you may lose the opportunity to buy.
Additional Stock Order Types
Now that we've explained the two main orders, here's a list of some added restrictions and special instructions that many different brokerages allow on their orders:
Stop-Loss Order
A stop-loss order is also referred to as a stopped market, on-stop buy, or on-stop sell, this is one of the most useful orders. This order is different because, unlike the limit and market orders, which are active as soon as they are entered, this order remains dormant until a certain price is passed, at which time it is activated as a market order.
For instance, if a stop-loss sell order were placed on the XYZ shares at $45 per share, the order would be inactive until the price reached or dropped below $45. The order would then be transformed into a market order, and the shares would be sold at the best available price. You should consider using this type of order if you don't have time to watch the market continually but need protection from a large downside move. A good time to use a stop order is before you leave on vacation.
Stop-Limit Order
These are similar to stop-loss orders, but as their name states, there is a limit on the price at which they will execute. There are two prices specified in a stop-limit order: the stop price, which will convert the order to a sell order, and the limit price. Instead of the order becoming a market order to sell, the sell order becomes a limit order that will only execute at the limit price or better. This can mitigate a potential problem with stop-loss orders, which can be triggered during a flash crash when prices plummet but subsequently recover.
All or None (AON)
This type of order is especially important for those who buy penny stocks. An all-or-none order ensures that you get either the entire quantity of stock you requested or none at all. This is typically problematic when a stock is very illiquid or a limit is placed on the order. For example, if you put in an order to buy 2,000 shares of XYZ but only 1,000 are being sold, an all-or-none restriction means your order will not be filled until there are at least 2,000 shares available at your preferred price. If you don't place an all-or-none restriction, your 2,000 share order would be partially filled for 1,000 shares.
Immediate or Cancel (IOC)
An IOC order mandates that whatever amount of an order that can be executed in the market (or at a limit) in a very short time span, often just a few seconds or less, be filled and then the rest of the order canceled. If no shares are traded in that "immediate" interval, then the order is canceled completely.
Fill or Kill (FOK)
This type of order combines an AON order with an IOC specification; in other words, it mandates that the entire order size be traded and in a very short time period, often a few seconds or less. If neither condition is met, the order is canceled.
Good 'Til Canceled (GTC)
This is a time restriction that you can place on different orders. A good-til-canceled order will remain active until you decide to cancel it. Brokerages will typically limit the maximum time you can keep an order open (or active) to 90 days.
Day
If you don't specify a time frame of expiry through the GTC instruction, then the order will typically be set as a day order. This means that after the end of the trading day, the order will expire. If it isn't transacted (filled) then you will have to re-enter it the following trading day.
Take Profit
A take profit order (sometimes called a profit target) is intended to close out the trade at a profit once it has reached a certain level. Execution of a take profit order closes the position. This type of order is always connected to an open position of a pending order.
Not all brokerages or online trading platforms allow for all of these types of orders. Check with your broker if you do not have access to a particular order type that you wish to use.
The Bottom Line
Knowing the difference between a limit and a market order is fundamental to individual investing. There are times where one or the other will be more appropriate, and the order type is also influenced by your investment approach.
A long-term investor is more likely to go with a market order because it is cheaper and the investment decision is based on fundamentals that will play out over months and years, so the current market price is less of an issue. A trader, however, is looking to act on a shorter-term trend in the charts and, therefore, is much more conscious of the market price paid; in which case, a limit order to buy in with a stop-loss order to sell is usually the bare minimum for setting up a trade.
By knowing what each order does and how each one might affect your trading, you can identify which order suits your investment needs, saves you time, reduces your risk, and, most importantly, saves you money.
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