Market Orders vs Limit Orders: Trading Basics

One of the best features added to grocery stores in the last few years has been the deli kiosk. Instead of waiting in line, you can punch your deli order into the computer and go on shopping for the rest of your list. When your number is up and your order is ready, it’ll be called out over the loudspeaker. Not only does this method save time, but it guarantees order accuracy.

Now imagine that the price of the deli meats changed every couple of seconds like the numbers on a stock ticker. If you thought prices were going up, you’d try to place your order immediately. However, if you thought you could get a better price later on, you might enter your order but wait until the price reached a certain level before completing the transaction. When the numbers move every minute like stock prices do, getting your shares at your ideal price can be difficult. That’s why it’s important to understand the difference between market orders and limit orders when entering trades.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

What is a Market Order?

A market order is the default order type on most brokerage accounts. When you execute a market order, you’re sending out a request for shares that will be filled at the National Best Bid and Offer (NBBO) price. The NBBO price isn’t necessarily the price of the shares at the time the order is sent, but the best available at the time the order is filled. According to the SEC, brokers must fill at the lowest available ask or highest available bid.

Pros of Market Orders

Here are some pros of market orders:

  • Immediate execution. A market order will be sent out and filled as quickly as possible, which can be beneficial in fast-moving markets where you don’t have time to set a limit price.
  • Higher probability of being filled. If you’re worried about getting your order filled on a stock with limited share availability or low volume, a market order has better odds of getting completely filled than a limit order.

Cons of Market Orders

Here are some cons of market orders:

  • Slippage. If a stock’s price is going parabolic and volume is coming in rapidly, your order might be filled way outside the parameters you preferred. Slippage isn’t always negative and you could wind up getting a better price than you envisioned. But negative slippage can leave you in a large hole before the shares even reach your account.
  • Lack of control. Using a market order means surrendering control to your broker to get you the best available price. And the best available price may not be the ideal starting point you were looking for on the investment.

What is a Limit Order?

A limit order is a market order with a price trigger. It won’t be executed until the stock being purchased reaches a certain price point. To place a limit order, you specify a price where you’d like to buy or sell shares and send it to your broker. The order will remain open until the stock reaches your pre-determined price, at which point it will change into a market order and execute.

Pros of Limit Orders

Here are some pros of limit orders:

  • More control over price. Limit orders are used to get specific entry and exit points on trade execution. A limit order is less likely to experience slippage and won’t execute if the price moves in the other direction.
  • Extended hours trading. Using limit orders will allow you to trade outside the normal 9:30 a.m. to 4:00 p.m. EST trading hours. Extended-hours trading has low volume and higher volatility, so market orders can’t be used. A market order placed during extended hours will be executed immediately when the market resumes normal trading hours, which could be a disaster if the stock makes a big move premarket.

Cons of Limit Orders

Here are some cons of limit orders:

  • Might go unfilled. A limit order is a good way to get a trade executed on your terms, but you run the risk of the stock price never moving toward your set limit. A limit order may go unfilled or get only partially filled if volume dries up.
  • Tough to execute in illiquid markets. Stocks with little volume or low floats (meaning few available shares) could be difficult to acquire with limit orders. If you want a 100% fill in a low-float stock, a market order may be the only way to get it done.

Stop-Loss Orders

The stop-loss order is a special type of order that you can attach to shares you already own. A stop-loss is a limit order that automatically triggers when a predetermined price is reached, but in this scenario, it’s a sell order on shares in your own account.

Why use a stop loss? In volatile markets, a stop loss can be used to limit downside potential. If you buy shares of ABC stock at $10 a share and are only comfortable losing 10% on the trade, a stop-loss set at $9 will automatically execute if your position loses 10%. A stop-loss can also be used to lock on profits on a winning trade. With a stop loss, you’ll be leaving directions on when to exit a trade so you don’t need to constantly monitor your shares in volatile markets.

Contact Good Life Financial Advisors of Mt. Pleasant

Understanding market orders and limit orders is crucial for trading. If you have any questions, reach out to a team member from Good Life Financial Advisors of Mount Pleasant for assistance.

Disclosure

The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing includes risks, including fluctuating prices possible loss of principal. No investment strategy assures a profit or protects against loss.