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Market Orders vs. Limit Orders

SmartAsset: Market Orders vs. Limit Orders

A transaction order is a set of instructions to buy or sell a security, such as a stock, and it sets the conditions under which you want that transaction to happen. If a broker manages your portfolio, your transaction order will send instructions to them. If you use an online system, the computer will process your transaction order.

There are four common types of transaction orders: market; limit; stop-loss; and stop-limit. Recently we covered stop-loss and stop-limit orders. In this article we will discuss market orders and limits.

A financial advisor can help you create a financial plan for your investment needs and goals.

What Is a Market Order?

A market order is an instruction for your portfolio to buy or sell a given stock immediately. You have told it to buy or sell “at the market price.” In a market order you give your portfolio three main conditions: Which stock to trade, how many shares to trade and whether to buy or sell it.

This order happens immediately. Once you give your portfolio the instruction to buy or sell it immediately goes out to make the transaction at the best price available. For most people, this is how they interact with the stock market.

The advantage of a market order is speed. Your portfolio will conduct the transaction as soon as it can find someone to sell you that stock or buy it from you. This makes market orders particularly valuable for high-volatility markets. If things are moving quickly, the speed of a market order lets you make sure that your transaction is not delayed.

That said, market orders bring with them a degree of unpredictability. You can’t know the exact price your stock will trade at when the order finally executes. A market order will make the transaction at the best price available at the time it goes through, not the price at the time you gave the instruction.

For example, say Stock A currently trades for $10 per share. You believe it will go up, and place a market order to buy 100 shares of Stock A. In the time it takes for your order to process and execute, the stock’s price increases to $12 per share. You will buy 100 shares of Stock A at $12 per share, spending $1,200 on the transaction.

In this example we see some of the benefits and disadvantages of a market order. You placed the order when the transaction would cost you $1,000 total. You had no control over the price fluctuations, and so couldn’t know that the stock would ultimately cost $200 more. Further, there is a question of how high you think Stock A will go. In the time it took you to buy this stock its value popped 20 percent. Do you think it will keep improving, or have you already lost the opportunity to make real gains?

On the other hand, this is clearly a high volatility stock. That kind of price jump in such a short period of time means that you can probably expect large changes coming soon. By executing a market order to buy you got in ahead of those changes. This let you purchase the stock before it had a chance to potentially climb higher, an opportunity that more complex trade instructions might have missed.

What Is a Limit Order?

SmartAsset: Market Orders vs. Limit Orders

Limit orders can be buy-limit orders or sell-limit orders. In either case, such an order is an instruction to buy or sell a given stock for a set price or better. Note that the phrase “a set price or better” assumes that you have taken a long position, that is, you expect the security to gain value. In a buy-limit order, your instruction is to buy the stock for a given price or less. In a sell-limit order, your instruction is to sell the stock for a given price or more. Short-sellers, those who expect a security to lose value, will generally not do well using limit orders.

There are four elements to a limit order: Which stock to trade; how much of it; whether to buy or sell; and the limit price.

For example, say that Stock B currently trades for $5. You could set a limit order to buy 100 shares of Stock B at a limit price of $4. Under this instruction, if the price of Stock B ever goes to $4 or below, there will be an automatic attempt to buy it. If you currently hold the stock, you could set a limit order to sell 100 shares of Stock B at a limit price of $6. Under this instruction, if the price of Stock B ever goes above $6, there will be an attempt to sell it.

In a limit order, there will be no transaction outside of your limit.

For example, say that you place your limit order to buy Stock B at $4. The price then goes to $4, and your broker or online system attempts to purchase 100 shares of the stock. However, before your portfolio can execute the transaction, Stock B’s price goes up to $4.10. The stock will not be purchased.

The advantage of a limit order is that it lets you set the terms of your transaction. A given stock might be only worthwhile to you if it is within a certain price range, so you can set the terms of your portfolio around those limits. It also works well in a volatile market. Setting limit orders lets you trade even if you aren’t actively monitoring the market, potentially letting you capture even brief moments when a stock hits your preferred price.

The disadvantage of a limit order is that it might simply never happen. If the stock never hits your chosen price, you might miss out on the chance to capture smaller gains while holding out for larger ones. In our example, say that Stock B goes down only to $4.01 per share. Your limit order would never execute, even though a single penny’s difference in the stock price might not change the profitability of your position.

This makes limit orders a useful tool but one that you must use carefully.

Bottom Line

SmartAsset: Market Orders vs. Limit Orders

Trading instructions are a crucial investment tactic. One of the most common trading instructions is a market order, which can be for either buying or selling. That’s an order that executes regardless of how prices change between the time you initiate your order and it is fulfilled. A limit order, which can be either a buy-limit or sell-limit order, will only execute if the price falls within your specified limit. Market orders are often best when moving quickly is the priority; limit orders are often best when there is a large bid-ask spread.

Tips for Investing

  • Consider talking to a financial advisor about market orders and limit orders. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Learn more about your available order options and how they can help you. Be aware that limit orders can get complicated. This article will help you understand the ins and outs of this powerful tool.

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