If you’ve ever bought or sold stocks or any other type of security through an investment broker, you probably already know what a market order is. But unless you are a frequent trader, you’re probably much less familiar with limit orders. The difference between market orders and limit orders isn’t a matter of one being better than the other. Each has its own place in your investment strategy.
Between the two order types, limit orders are definitely the more complicated version. But there are times when a limit order can help you to get the right price on a security, whether you are buying or selling.
Market order vs. limit order
Market orders and limit orders are both frequently used by investors. That’s because each serves a different purpose, whether you are buying or selling a security.
Market orders
A market order, as the name implies, is when you buy or sell a security at the current market price. It’s the simplest type of order because it can be executed immediately at whatever the current price of a security might be. Market orders are also the easiest type of orders for a broker to execute. Since they take place immediately, there is no need for the broker to maintain a record of a pending transaction.
Because the investor is accepting the security price available at the moment, a market order also has the greatest likelihood of being executed. Since the investor has no preference with regard to the price of the security, the trade can be executed in the shortest amount of time.
However, even though a market order has no price preference, the price of a security can vary between placement and completion. For example, an investor may place a trade to purchase a stock at $41.50 per share, but the trade may be executed at $41.80 a share, because of continuous market fluctuations.
This can happen even though a market order is executed in just seconds. The variation in price between placement and settlement can be even greater if there is an unusual amount of activity with the stock being purchased or sold.
Limit orders
Limit orders are somewhat more complicated than market orders, but the job is made much easier since the advent of computerized trading. With a limit order, the investor sets a specific price at which she is willing to buy or sell a security. A limit order is placed with a broker, and will automatically be triggered when a security reaches the target price.
For example, let’s say the investor is considering purchasing stock in ABC company. The stock is currently trading at $67 per share, which the investor believes to be a bit rich. He decides to purchase the stock using a limit order set at $63. If the stock price falls to $63, the limit order will be triggered and the stock will be purchased. But if the stock price never falls to $63, the trade will never take place.
Limit orders can also be used to set the price for the sale of a security. For example, if the same investor purchases ABC stock at $63 per share, he may decide to set a sell limit price of $80. If the price of the stock reaches $80, the sale will be automatically triggered.
A common type of limit order used to set the sale price of a stock is a stop order or a stop loss order. This is a special type of order that protects the investor when the stock price falls below the price at which it was purchased. For example, an investor may purchase a stock at $100 but set a stop order at $90. Should the price of the stock fall to $90, a sale will be triggered.
That doesn’t mean all shares will be sold at $90. A 100-share block trade may sell 70 shares at $90, and 30 shares at $89.75.
There is however a limitation with limit orders. For example, let’s say you set the sale price of a stock at $55. If there’s heavy selling activity with the stock, the price may fall below – even well below – $55 before the sale is executed. It’s conceivable, the price will fall all the way to $49 before the trade is actually completed. A limit order is only a trigger to buy or sell as security, but not a guarantee on a specific price.
Major investment brokers, like TradeStation and J.P. Morgan Self-directed Investing, commonly offer limit orders.
When should you use a market order?
A market order should be used on any trade where you don’t have a preference on the specific price at which the security is purchased or sold. The investor might make a determination that the current market price is reasonable as it is.
A market order is also an excellent idea if you’re looking to make a trade quickly. Since the trade will take place at the current market price, the investor will not need to wait to buy or sell the security.
Market orders often make more sense for buy-and-hold investors who are more concerned with long-term price patterns than short-term fluctuations.
When should you use a limit order?
A limit order is best used when you are looking to buy or sell a security at a specific price. This can be an especially important tool with a particularly volatile security. You may be interested in purchasing a stock but only at a certain price point.
The same is true on the selling side. Let’s say you purchased a stock at $100, and you feel it may become overvalued beyond $120. To avoid taking that chance, and to lock in your profit, you set a limit order at $120. When the price is reached, the sale will be triggered.
One of the big advantages of limit orders is that they can eliminate the need to “babysit” a security. For example, absent a limit order, you may find yourself continuously tracking the above stock when the price reaches $115, waiting for the moment to unload it. But by setting a limit order, there’s no need to monitor the stock price. You’ll set the sale limit, and the trade will happen automatically.
Limit orders may also be important tools for stock traders, who may be looking for very specific price points on both the buying and selling side.
Frequently asked questions (FAQs)
Which is better, a limit order or a market order?
Neither – it all depends on what it is you’re trying to accomplish. If you like the price of a security you are looking at right now, a market order is the best way to take advantage of that price. But if you feel a better price is possible, either in buying or selling a security, then a limit order may prove to be the better choice.
Are market orders more expensive than limit orders?
No. Market orders are the simplest type of order since they are executed immediately. That means they are usually the least expensive type of trade.
With many brokers, there’s no difference in pricing between a market order and a limit order. However, you should check with your broker to determine if there is any variation in the fees charged between the two orders.
Is a limit order safer than a market order?
A limit order can be safer only in the sense that it gives you some control over the price at which you want to buy or sell a security. For example, let’s say the price of a stock has been bouncing around in the $70 to $80 range. To maximize your profit, you set a limit order to purchase the stock at $70.
If the stock falls to $70 and you purchase the stock, that may be safer than buying the stock at $75 at today’s market. However, there is no guarantee the limit price will be reached. Should that happen, the limit order will prove to be less safe than a market order.
What is the disadvantage of a limit order?
The primary disadvantage of a limit order is that the trade may never be executed if the security never reaches the limit price. For example, if you set a limit price to buy a security at $50 per share, the sale may never take place if the security price never reaches that level.
INVESTMENT AND INSURANCE PRODUCTS ARE: NOT A DEPOSIT • NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE
