The stock market is complex and can be volatile. But there are strategies and tools available to make it potentially easier to navigate.
Experienced traders and investors know this, so they use some of these trading strategies and tools to help minimize losses, enter and exit positions quickly, or maximize their profits when they purchase and sell stocks.
Of the tools and tactics available, two of the most common are how stocks are bought and sold, using what’s called a market order or a limit order.
The difference between the two generally lies in whether investors want to buy right away or have a predetermined price at which they’d like to participate, some time in the future.
A market order is an order a trader places to buy or sell stock, at the current market price available in the market. A limit order, on the other hand, is set to buy or sell a stock at a specific or better price than what’s available at that moment.
Here’s a deeper dive on these two stock order types and how you can use them.
A market order is a request to buy a stock at the best price available in the market at that time. Once you place an order, via the click of a mouse or through your broker’s trading platform — your order will be fulfilled, usually within seconds.
Market orders are generally used when you want to buy or sell stocks now, instead of later, and if you feel the price is reasonable for your portfolio. Market orders submitted through your broker are fulfilled this way on stocks listed on registered exchanges, rather than through the over-the-counter market. Typically, your chances of the order being executed as near to the price you want at that moment is higher in stocks where the volume of trading activity is higher. These stocks are typically more “liquid” than stocks where the trading activity is sparse, which may mean the price you receive for your order may differ from what you expected.
A limit order is a request you place with your broker that sets certain “limits” – a ceiling or floor price – on trades. When you place a limit order, you are placing an order to buy or sell a stock and establish the maximum price to be paid or the minimum price to be received (the “limit price”). If the order is filled, it will only be done if the price is at or better than the specified limit price.
For instance, if you want to buy a stock at $10.00, and it is currently trading at $10.70, you can place a buy limit order to trigger when the stock trades at $10.00. The limit order will only get executed if the stock price reaches the trigger ($10.00) and below (<$10.00), so that you are buying at a more advantageous price. Likewise, if you already own a stock at $10.00 and want to sell at a price higher than the market, at say $11.00, you can use a limit order so that when the price rises to your limit, it will only be executed at the “floor” price ($11.00) and above (>$11.00).
Limit orders are generally used by traders who are interested in entering and exiting positions at predefined prices – whether that is to lock in profits or avoid losses in excess of their tolerance levels. Most trading platforms will offer the ability to use limit orders as you see fit. The alternative is to buy and hold an investment over a time frame of your choosing.
Market orders are generally executed at the time the order is entered because they buy stocks at whatever price is available in the market. When this type of order is selected, there is no guarantee of an exact price — the buyer or seller simply buys or sells the stock at whatever the price may be at the time the order is fulfilled, which usually happens quickly after an order is submitted.
Limit orders attempt to predict the direction in which a stock price moves — they might even result in a scenario where a trader who, in theory, wants to sell a stock, but may end up holding that stock for months until the limit order or ideal price is reached.
As with all investment tools and strategies, there are risks involved. Along with the inherent risks in the way you invest and trade – and the market itself– each of these orders adds additional risks that you should consider if you’re debating their use.
With market orders, you can determine how many shares of a company you want to buy or sell at the price you see available in the current market.
However, it’s important to note that between the time you click “buy” or “sell” and the time the trade is executed, market conditions or volatility in the price could change. There also is a risk of insufficient supply of stock available for your purchase at the price you see in the market. For instance, the price could move as other investors may have placed their trades immediately ahead of yours, thereby absorbing the available supply of shares. Given the auction-based nature of the exchanges, your trade would then be executed at a higher price that is then offered. This concept is called slippage. Slippage can cause you to spend or lose more money than you thought on a trade, even if you placed a market order.
Here’s an example:
Say you wanted to buy 200 shares at the current market price of $34.67, and there were 500 shares available at that price. You place a market order, knowing you’ll be purchasing them at a price you feel comfortable with at the moment. What you didn’t anticipate was orders by several other market participants that arrived at the exchange before yours, which absorbed the 500 shares at that price. Stock orders are executed in the order they are received — and by the time your order was completed, the price of the stock rose to $39.67. Therefore, instead of spending $6,934 on 200 shares, your order was executed at a total cost of $7,934.
Because a limit order is designed to buy a stock at a specific price or less, or sell a stock at a specific price or more, there is a chance that your order may not be filled completely.
For instance, imagine there is a stock you like with a market price of $34.67. You feel certain that its price will decrease, so you place a limit order to buy shares at a lower price. You set your limit at $33.00 and wait — but the order is never filled because the price actually increases from $34.67 to $37.67. You also may encounter a situation, known as a “partial fill,” where there is insufficient supply available at the price you set. The share price may briefly drop to $33.00, but there were only a few shares being sold at that price, and your remaining order goes unfilled. If there are commissions associated with transactions, if the remaining part of that order is filled on another day, you may be charged another commission – even if it’s part of the same order.
Choosing between a market order and limit order comes down to your goals and comfort level.
Ultimately, all investing and trading practices come with risks — market and limit orders are no different. The main takeaway is knowing how to use such strategies or to lessen the financial risks you face when investing in the stock market.
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