Market order vs. Limit order: when to use which
When you are ready to buy or sell a stock or fund, there are two main ways you can determine the price at which you will trade: the market order and the limit order. With market orders, you trade the stock regardless of the going price. With limit orders, you can name a price, and if the action hits it, the trade is usually executed.
This is the most fundamental difference between a market order and a limit order, but each type may be more appropriate for a given trading situation. Here is what you need to consider.
Market orders: trade now
The biggest advantage of a market order is that your broker can execute it quickly because you tell the broker to take the best price available at that time. If you buy a stock, a market order will execute at the seller’s asking price. If you sell, a market order will execute at the buyer’s auction.
The biggest downside to the market order is that you can’t specify the trade price. Many times it doesn’t matter, however. For large companies that are very liquid (high volume trading), the difference between the bid price and the ask price – called the bid-ask spread – is usually only a penny or two. Unless you buy a large number of stocks, this difference doesn’t matter.
“You cannot specify the price of the exchange. Many times it doesn’t matter, however.“
However, if the price moves quickly, you could end up trading at a much different price than where you entered the order. It is rare but possible. A more likely scenario: You enter a market order after the stock market closes, and then the company announces news that affects its share price. If you don’t cancel the order before the exchange opens the next day, you could end up trading at a much different price than you expected.
Another potential downside occurs with illiquid stocks, those that trade at low volume. When you enter a market order, you can raise or lower the price of the stock because there are not enough buyers or sellers at the time to cover the order. You will end up with a very different price than in previous moments because your order influences the market.
Go with a market order when:
You want fast execution at all costs
You are trading a very liquid stock with a narrow bid-ask spread (usually a dime)
You trade only a few stocks (for example, less than 100)
Limit orders: trade when the price is right
The biggest advantage of the limit order is that you can name your price, and if the stock hits that price, the order will likely be filled. Sometimes the broker will even fill your order for a better price. Typically, you can set limit orders to execute for up to three months after entry, which means you don’t have to compulsively monitor to get your price.
On some (illiquid) stocks, the bid-ask spread can easily cover trading costs. For example, if the spread is 10 cents and you buy 100 stocks, a limit order for the lowest bid price would save you $ 10, enough to cover the commission. with many top brokers.
Biggest downside: You are not guaranteed to trade the stock. If the stock never hits the limit price, the trade will not complete. Even if the stock is reaching your limit, there may not be enough demand or supply to fill the order. This is more likely for small, illiquid stocks.
“If the stock never hits the limit price, the trade will not complete. Even if this is the case, there may be insufficient demand or supply.“
Another downside, especially with an order that can fill up to three months in the future, is that the stock can move dramatically. Your trade may be executed at a significantly different price than what you might have otherwise obtained.
Imagine Apple announces a potentially huge new product and its inventory climbs from $ 190 to $ 210, while you have a limit order to sell at $ 192. Unless you watch the news closely, you could end up selling $ 192 when you could have received more. The reverse can happen with a buy limit order when bad news comes up, such as a bad earnings report. You could end up buying at a much higher price than what you might have had or now think the action is worth.
Opt for a limit order when:
You want to specify your price, sometimes very different from where the stock is
You want to trade an illiquid stock where the bid-ask spread is large (usually more than 5 cents)
You trade a large number of stocks (for example, more than 100)
A smart way to save money
Limit orders can help you save money on commissions, especially on illiquid stocks that bounce around bid and ask prices. But you’ll also save money by adopting a buy and hold mentality in your investments. Because you avoid selling out of the market, you’ll incur fewer commissions and avoid capital gains taxes, which could easily eclipse trading costs. Plus, you’ll want to stay invested let compound growth work its magic.