Written by: Taranjit Singh
Date: 27-11-2023
When you want to buy or sell a stock, you have two main options: a market order or a limit order. These are two types of orders that tell your broker how to execute your trade. Choosing the right order type can make a difference in the price, speed, and outcome of your transaction. In this article, we will explain what market orders and limit orders are, how they work, and when to use them. We will also provide some examples, FAQs, and key takeaways to help you understand the pros and cons of each order type.
What Is a Market Order?
A market order is an instruction to buy or sell a stock immediately at the best available price in the current market. It is the simplest and fastest way to execute a trade, as it does not specify any price limit. A market order guarantees that your order will be filled, but not the price at which it will be filled. The actual execution price may differ from the last traded price or the quoted price, especially if the market is volatile or the stock is illiquid.
For example, suppose you want to buy 100 shares of XYZ stock, which is currently trading at $50 per share. You place a market order to buy, and your broker executes it at the next available price. If the market is stable and there are enough sellers, you may get your order filled at $50 or close to it. However, if the market is moving fast and there are few sellers, you may end up paying more than $50 per share. Similarly, if you place a market order to sell, you may get a lower price than the last traded or quoted price.
What Is a Limit Order?
A limit order is an instruction to buy or sell a stock at a specific price or better. It allows you to set the maximum price you are willing to pay for a buy order or the minimum price you are willing to accept for a sell order. A limit order gives you more control over the execution price of your trade, but it does not guarantee that your order will be filled. Your order will only be executed if the market price meets or exceeds your limit price. If the market price never reaches your limit price, your order will remain unfilled until you cancel it or it expires.
For example, suppose you want to buy 100 shares of XYZ stock, which is currently trading at $50 per share. You place a limit order to buy at $48, meaning you are willing to pay up to $48 per share. Your order will be placed in a queue and wait for a seller who is willing to sell at $48 or lower. If the market price drops to $48 or below, your order will be executed at your limit price or better. However, if the market price stays above $48, your order will not be executed.
Market Order vs. Limit Order: Comparison
Here are some of the main differences between market orders and limit orders:
Speed: Market orders are executed as soon as possible, while limit orders may take longer or never be executed.
Price: Market orders do not specify a price, while limit orders do. Market orders may result in a higher or lower price than expected, while limit orders ensure a price at or better than the limit.
Execution: Market orders guarantee an execution, while limit orders do not. Market orders are subject to availability and liquidity, while limit orders are subject to price and demand.
Cost: Market orders may incur higher transaction costs, such as slippage and market impact, while limit orders may incur lower or no transaction costs. However, some brokers may charge higher fees for limit orders than market orders.
When to Use a Market Order vs. a Limit Order
The choice of order type depends on your trading objectives, preferences, and risk tolerance. Here are some general guidelines on when to use a market order or a limit order:
Use a market order when you want to execute a trade quickly and are not concerned about price fluctuations. Market orders are suitable for highly liquid and stable stocks, or when you have a small order size that will not affect the market price significantly.
Use a limit order when you want to execute a trade at a specific price or better and are willing to wait for the market to reach your limit. Limit orders are suitable for illiquid or volatile stocks, or when you have a large order size that may affect the market price significantly.
Examples of Market Order vs. Limit Order
To illustrate the difference between market orders and limit orders, let’s look at some hypothetical examples.
Example 1: Buying a Stock with a Market Order
Suppose you want to buy 100 shares of ABC stock, which is currently trading at $10 per share. You place a market order to buy, and your broker executes it at the next available price. The following table shows the possible outcomes of your order, depending on the market conditions:
As you can see, the execution price of your market order may vary from the last traded price or the quoted price, depending on the market direction and speed. You may end up paying more or less than you expected, but you are guaranteed to get your order filled.
Example 2: Buying a Stock with a Limit Order
Suppose you want to buy 100 shares of ABC stock, which is currently trading at $10 per share. You place a limit order to buy at $9.50, meaning you are willing to pay up to $9.50 per share. The following table shows the possible outcomes of your order, depending on the market conditions:
As you can see, the execution price of your limit order is fixed at your limit price or better, but your order may not be executed at all if the market price never reaches your limit. You may miss the opportunity to buy the stock, but you are protected from paying more than you want.
Example 3: Selling a Stock with a Market Order
Suppose you want to sell 100 shares of XYZ stock, which is currently trading at $20 per share. You place a market order to sell, and your broker executes it at the next available price. The following table shows the possible outcomes of your order, depending on the market conditions:
As you can see, the execution price of your market order may vary from the last traded price or the quoted price, depending on the market direction and speed. You may end up receiving more or less than you expected, but you are guaranteed to get your order filled.
Example 4: Selling a Stock with a Limit Order
Suppose you want to sell 100 shares of XYZ stock, which is currently trading at $20 per share. You place a limit order to sell at $21, meaning you are willing to accept at least $21 per share. The following table shows the possible outcomes of your order, depending on the market conditions:
As you can see, the execution price of your limit order is fixed at your limit price or better, but your order may not be executed at all if the market price never reaches your limit. You may miss the opportunity to sell the stock, but you are protected from receiving less than you wanted.
How do I place a market order or a limit order?
You can place a market order or a limit order through your online broker platform or app. You will need to enter the stock symbol, the order type, the number of shares, and the price (if it is a limit order). You will also need to specify the duration of your order, such as day, good till canceled (GTC), or immediate or cancel (IOC).
What are the advantages and disadvantages of market orders?
The advantages of market orders are that they are simple, fast, and guaranteed to be executed. The disadvantages of market orders are that they do not specify a price, and may result in a higher or lower price than expected, depending on the market conditions and the stock liquidity.
What are the advantages and disadvantages of limit orders?
The advantages of limit orders are that they specify a price, and ensure a price at or better than the limit. The disadvantages of limit orders are that they are not guaranteed to be executed, and may miss the opportunity to buy or sell the stock, depending on the market conditions and the stock demand.
What are some other types of orders besides market orders and limit orders?
Some other types of orders are stop orders, stop-limit orders, trailing stop orders, and fill or kill orders. These orders are used to trigger a market or a limit order when certain conditions are met, such as a price level, a percentage change, or a time limit, such as a market close or a specific date. These orders are used to protect profits, limit losses, or execute trades at specific points. However, these orders are also subject to the same advantages and disadvantages of market orders and limit orders, depending on the order type they trigger.
Key Takeaways
- Market orders and limit orders are two types of orders that tell your broker how to execute your trade.
- Market orders are instructions to buy or sell a stock immediately at the best available price in the current market.
- Limit orders are instructions to buy or sell a stock at a specific price or better.
- Market orders guarantee an execution, but not a price. Limit orders guarantee a price, but not an execution.
- Market orders are suitable for highly liquid and stable stocks, or when you want to execute a trade quickly and are not concerned about price fluctuations.
- Limit orders are suitable for illiquid or volatile stocks, or when you want to execute a trade at a specific price or better and are willing to wait for the market to reach your limit.
- Market orders and limit orders have different advantages and disadvantages, depending on your trading objectives, preferences, and risk tolerance.
Bottom Line
Market orders and limit orders are two of the most common and basic order types that you can use to buy or sell stocks. They have different features, benefits, drawbacks, and strategies, depending on the market conditions and the stock characteristics. Choosing the right order type can make a difference in the price, speed, and outcome of your transaction. Therefore, you should understand how market orders and limit orders work, and when to use them, before placing your trade. You should also consider other factors, such as your trading goals, risk tolerance, and transaction costs when deciding which order type to use. Ultimately, the choice of order type depends on your personal preference and judgment, as well as your experience and skill level.