Market order vs. Limit Order: Explanation of the Differences
Market order vs. limit order: an overview
When an investor places an order to buy or sell a stock, there are two basic execution options:
- Place the “market” order: Market orders are transactions intended to be executed as quickly as possible at the current market price.
- Place the order “at the limit”: Limit orders set the maximum or minimum price at which you are willing to buy or sell.
Buying stocks is like buying a car. With a car, you can pay the dealership sticker price and get the car. Or you can negotiate a price and refuse to complete the deal unless the dealership matches your assessment. 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 completion of the transaction. Limit orders, on the other hand, deal primarily with price. Thus, if the security’s value is currently outside the parameters defined in the limit order, the trade does not take place.
Key points to remember
- Market orders are transactions intended to be executed as quickly as possible at the current market price.
- Limit orders set the maximum or minimum price at which you are willing to complete the trade, whether it is a buy or a sale.
- Market orders offer a greater likelihood of an order going through, but there is no guarantee as the orders are subject to availability.
Understanding Market Orders and Limit Orders
When a layman imagines a typical stock market transaction, he thinks of stock market orders. These orders are the most basic buy and sell transactions, where a broker receives an order to trade in securities and then processes it at the current market price.
For example, an investor enters an order to buy 100 shares of a company XYZ Inc. “at the market”. Since the investor opts for the price of XYZ shares, the trade will be executed fairly quickly, regardless of the current price of that security.
Even though market orders offer a greater probability that a trade will be executed, there is no guarantee that it will actually be executed. All stock market transactions are subject to the availability of particular stocks and can vary widely depending on the timing, order size and liquidity of the stock.
All orders are processed under current priority guidelines. Whenever a market order is placed, there is always a risk of market fluctuations between the time the broker receives the order and the time the trade is executed. This is of particular concern for larger orders, which take longer to fill and, if large enough, can actually move the market on their own. Sometimes, trading of individual stocks can also be halted or suspended.
It should also be borne in mind that a market order that is placed after trading hours will be executed at the market price at the opening of the next trading day.
Limit orders are designed to give investors more control over the buying and selling prices of their trades. Before placing an order, a maximum acceptable purchase price amount must be selected. The minimum acceptable selling prices are indicated on the order forms.
A limit order offers the advantage of being assured that the point of entry or exit of the market is at least as good as the price specified. Limit orders can be particularly advantageous when trading a stock or other asset that is lightly traded, highly volatile, or has a large bid-ask spread: the difference between the highest price a bidder is. willing to pay for an asset in the market and the lowest price a seller is willing to accept.Placing a limit order limits the amount an investor is willing to pay.
Let’s look at an example. If an investor is worried about buying XYZ stocks at a higher price and thinks it is possible to get them at a lower price instead, it may be a good idea to enter a limit order. If at any time during the trading day XYZ drops to the lower or lower price, the order will be triggered and the investor will have bought XYZ at the specified predefined limit order price or less. Of course, this also means that if at the end of the trading day XYZ does not drop as low as the limit order set by the investor, the order will not be executed.
Traders should be aware of the effect of the bid-ask spread on limit orders. For a limit buy order to be executed, the ask price, and not just the ask price, must fall to the price specified by the trader.
It is common practice to allow limit orders to be placed outside of market hours. In these cases, limit orders are placed in a queue for processing as soon as trading resumes.
The risk inherent in limit orders is that if the actual market price never falls within limit order guidelines, the investor’s order may not be executed. 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 partial execution or no execution at all due to its price restriction.
Limit orders are more complicated to execute than market orders and may therefore incur higher brokerage fees. That said, for low volume stocks that aren’t listed on major stock exchanges, it can be difficult to find the actual price, which makes limit orders an attractive option.