Limit or Market?
Ah, the million dollar question. Limit or market? This is a debate that is popular with both newbie and even some veteran traders alike. This sounds like a simple, basic topic, but I was quite surprised at how many people, even seasoned traders, didn’t seem to understand what a limit or market order really is. So let’s dive in and clarify what exactly they are and when to use them.
What is a market order? A market order, by definition, is a request to buy or sell a security at the best-available price at the current market. Market orders will go through immediately at the current best prices provided there are enough buyers or sellers at these price points. This form of order prioritizes execution of the order at the expense of where you might get executed. Market orders are often cheaper to execute and also have priority for executions over other types of orders such as limit orders.
For example, if a stock is trading at $3.05 x $3.10 and you send out a market buy order 1000 shares you will most likely be filled at $3.10 provided that there are sellers there to fill your buy order. If your market buy order is placed and the market inexplicably jumps up to $3.15 x $3.20 or higher before you can blink, then that means you may be filled at a less disadvantageous price than expected. This is called market slippage or more comically, a fat finger, which is the main draw down to using a market order. This can also happen if you are using too much size relative to the volume of the security. For instance you decide to market order 10,000 shares while there is a $3.05 bid and $3.10 offer there might not be enough liquidity at those price points to fill your full order at the most ideal prices. This can result in slippage as the market makers will essentially take as many offers as it needs to completely fill your large order. This can put you down a few #bigmacs instantaneously as you might get an extremely bad execution price. Always be aware of the volume and spreads of the bids and offers to make sure you stay safe when using market orders as they’re basically a carte blanche to the market makers to fill you whatever they want.
A slightly more complex (but not too complex) order type is a limit order. A limit order is a buy or a sell at a specific price or better. There is no guarantee that this order will be executed if there isn’t enough liquidity to fill your entire order at your specified price. If you initiate an order at a specific limit price, you are sending an instruction that says: fill my order at this price or better.
Say a stock is trading at $3.05 bid and $3.10 offer, you want to buy this stock but you don’t want to pay more then $3 for the stock. In this case you would use a limit order and put a price of $3. The market would need to reach that price or lower to execute your orders. While the market may never actually hit that price point, the limit order ensures that you never pay more than your specified price. You can also put a buy order at a limit of $3.1 which would result in you filling your order of the specified amount of shares up to $3.1. Liquidity still needs to be observed as low liquidity will make it difficult to fill a large order. Overall, a limit order, in contrast to a market order, prioritizes execution price point at the expense of the execution itself.
I also want to point out the crucial difference between a stop order (or stop-loss order) and a stop limit order, which are NOT the same.
A stop order is basically telling the market to exit your position once the stock has moved against you to the targeted price. At this price, the stop order will turn into a market order and once again, liquidity will come into play as exiting a large position using a stop order could result in market slippage. So if you are long a stock at $3.1 and you have an existing stop order at $3, then if the stock falls to $3, then you triggered your stop and your order turns into a market sell order giving you the best available fill at that instant.
A stop limit order is similar but instead turns into a limit order when the market has moved against you to the targeted price. So here if you are long a stock at $3.1 and if you have a stop limit order at $3, then if the stock falls to $3, your stop limit order will get triggered and will turn into a limit sell order at $3. Again, the same ideas apply with a stop limit order, as a lack of liquidity could result in your order not getting executed in its entirely.
So without throwing the book at you guys, hope this information helps you get a better understand to what these type of orders are and what they do exactly. Just keep in mind when choosing between a market or limit order that you must observe, your position size relative to the liquidity of the market. That’s the key takeaway here.
There are many more complex orders that we will dive into at a later point.
Market Order – The “I want in or out now and I don’t care what price” order.
Limit Order – The “I want in or out but I ain’t paying or accepting more than the specified price even if that means I won’t get all the shares I want executed” order
Stop (or Stop Loss) Order – the “get me outta here” order, market version.
Stop Limit Order – the “get me outta here” order, limit version.
As always, happy trading!
Your friendly neighborhood day trader,
Tired of never having shares to short? Does your broker just plain suck?Madaz recommends Centerpoint Securities as the preferred broker.
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Affiliate Disclosure: I know what you're thinking. Madaz, ya sneaky bastard, trying to sneak in some affiliate links. Any compensation I may receive from this will pay for big macs on days where the market isn't feeling so charitable. For a more complete version of this mumbo jumbo, please click here.