There are many ways to purchase stocks. Among them are immediate orders and conditional orders. This article looks at the difference between market orders and limit orders.
When you imagine the stock market, don’t think of it as walking into a store and buying an item with a price tag and a set price. Think of it like an actual market place, where there are many competing businesses and everyone there is fighting for the best deal with shop owners who are ready to make you a deal. This is similar to the kind of negotiation that takes place in the stock market. The listed price or value is just a place to begin negotiations.
There are two major differences between market orders and limit orders. Market orders are executed quickly at the market price. For limits, on the other hand, it is only when the price meets the conditions of the order does the limit order get processed. Let’s talk about what that means for both kinds of orders.
An investor uses a market order when they just want to get a hold of a specific stock or security as fast as possible. That means they will have to pay the current asking price or more depending on the actual time the sale closes.
Limit orders do not execute immediately but only go through when set conditions are met. The conditions of a limit order are set by the buyer in the case of a limit order to buy; by the owner in the case of a limit order to sell. So with limits, there is a maximum purchase price or a minimum sale price which will only be active in the future, but no sale takes place at the time of the order.
Why place an Order?
When you give a market order to your broker, it indicates that you want the stock no matter the cost. This is because the order is made as soon as possible. Once the order is made, it goes in the queue with the other investors who want the asset. So in a market order, speed is at a premium and not the price of the desired holding.
It is also important to remember that there is no guarantee that the stock will be purchased even with a market order. Because the order is placed in a queue and is processed only once the market is open. That means that by the time your order comes up, there may be nothing left for sale.
All stock market transactions, even market orders, are subject to the availability of the given stocks. That means that their availability will vary significantly based on the timing, the size of the order, and the liquidity of the stock. However, a market order has the best chance of acquiring a stock quickly.
Why use a Limit?
A limit order to buy or a limit order to sell has many more limitations, hence the name. The gist of a limit is that there are limits on how much an investor is willing to pay for a stock or sell one that they own.
The major benefit of a limit order is that it makes acquiring stocks a more price conscious process. These orders have three main features:
- Limit order to Buy: Is set by the prospective buyer and sets a maximum purchase price.
- Limit order to Sell: The owner places a minimum sale price.
- Both have an agreed upon time-frame and set expiration date.
An investor can use a limit if the total cost is a priority over acquisition. Limit orders are executed only if the stock drops to the desired price. Also, it is possible that the order will expire before the price matches an order.
How do you know when to use a market order or limit order?
There are advantages to both of these strategies. The simplest answer whether to choose one method over the other is two-fold. One, it depends on the stock in question. And two, how much an investor is able to afford.
Limit orders are useful when trading stocks that are thinly traded, highly volatile, or has a wide bid-ask spread. The “bid-ask spread” is the difference between the highest price a buyer is willing to pay for an asset and the lowest price a seller will accept. Limit orders put a cap on the amount an investor is willing to pay for a given stock. But, if you want to get a hold of the stock quickly, a market order is likely the better move.
Review and Compare
There is always a threat of price fluctuation in the market, even after an order has been placed. This is more of a concern for those who want to make large acquisitions. Limit orders can therefore also be very helpful when trying to scoop up a large number of units. And, larger orders take longer to fill. So if you are working with a straight forward market order, if the order is large enough, that order can actually affect the market.
The greatest risk associated with limit orders is that the price may never fall to match the order. That means that the order will expire, and the purchase will not go through. It is also possible that there is not enough liquidity once the target price is reached. In this case, the full order does not get filled completely. It is, however, possible to have a partial fill of a limit order.
Finally, limit orders are more complicated to execute than market orders and subsequently can result in higher brokerage fees. An actual price of a stock can be difficult to detect on a low volume stock which is not listed with a major exchange. This makes limit orders an attractive option.
Limit Orders: A limit order places minimums on the sale, and maximums on the purchase of a stock. Limit orders are a kind of conditional order. Therefore, for the sale to occur the conditions of the contract must be met. With a limit order, the sale only goes through if the desired price of a buy or sell it met. These orders also expire. So, if the conditions are not met within the time-frame of the contract the order is canceled. Finally, because these are more complicated transactions they have more brokerage fees.
Limit Orders to Sell: Limit orders to sell is a limit that the owner of a stock uses. This order sets a minimum price on a stock’s potential sale. This means that the owner of the stock will only sell for a minimum price or higher.
Limit Orders to Buy: Buy limit means that the acquisition of new stock will only occur if the stock drops to the desired price limit or lower. As it is a limit, these also come with expiration dates. So, the purchase does not go through if the desired stock does not move down to meet the limit to buy. A buy limit order can be particularly helpful to an investor who wants to acquire multiple stocks. When buying multiples, a little saving can add up quickly, depending on the price.
Market Order: Market orders are orders with the highest rate of guarantee. This is because a market order is a direction to purchase a security at market value, as soon as possible. However, because this is an order to immediately purchase the stock, there is no price guarantee. It is possible the value, and therefore, the price will change from the time the order is made to the time it is processed.