When buying or selling a stock, there are two main order types you can place – market orders and limit orders. Understanding what they are will help your investment strategy and give you more confidence in the market.
A market order accepts the best available market price for the stock. That means:
- If you are buying a stock, you are willing to purchase at the highest available price offered in the market
- If you are selling a stock, you are willing to sell at the lowest available price bid by other investors in the market.
Through a market order, you don’t have control over the price you may pay or receive. It is used when you want to execute a trade quickly and are content with the market price at the time of transaction.
When you place a limit order, you set an instruction to execute the trade for a stock at a specific price or better, on the market. This approach is best for investors who desire the ability to determine the maximum buy price or the minimum sell price for their stock.
If you were to place a limit order for stock “ZZZ”, you’ll have to identify the following things:
- Transaction type (buy or sell the stock?)
- Number of shares
- The ticker of the stock
That would culminate in something like this: “buy/sell 500 shares ZZZ, limit $10.00”.
Here, you’ve identified the market action and the specific stock, with 500 shares at a $10 limit. This means that if you were to buy ZZZ shares, for example, you would have to wait until a seller is willing to transact below $10.
When should I use a market order?
You are selling large-cap stocks
Stocks with high capitalisations do not fluctuate as much as small-cap stocks. Thus, the bid and ask prices are typically close, and market orders are the best action to use
Time is of the essence
If liquidity is of the greatest importance, and you’d like to exit or enter a position regardless of time, then a market order is best because it is executed immediately.
You have a small number of shares
If you are only trading 50 shares of a company, then the difference between a market order and a limit order won’t drastically impact your final cost or profit. If you are trading a larger quantity, say 500,000 shares, then the potential price difference between a market order or limit order would be significantly larger.
However, if you want to transact a stock at a specific price, do not use a market order.
When should I use a limit order?
You know your price
If you know what your ideal entry or exit price is, then a limit order is your best option. This ensures that you enter and exit positions with your own conditions, rather than abiding by what the market says.
You’re active in a less liquid stock
If you are trying to buy or sell a penny stock, the market prices have a high tendency to move significantly due to high liquidity and often, high stock volumes. Using a limit order allows you to control your purchase and sale prices so that you are less impacted by rapid market movements that can hurt your back pocket
You have a lot of shares
When you have a lot of shares to buy or sell, it makes sense to try and place a limit order. Saving 5 cents a share across 500,000 shares is equivalent to saving $25,000, which represents capital that can best be allocated elsewhere.
Note that when you place a limit order it is not guaranteed you will execute your trade at all. Because the “order book” is ranked by price and then time, the cheaper “buy” orders, for example, may never be fulfilled.