When you buy or sell stocks, bonds, or mutual funds, you must decide how you want your broker to execute that trade. It may sound like a complicated process, but market orders make it relatively easy to trade without having to make difficult decisions as often.
What is a market order?
Market orders are the most popular and default choice for ordinary people who want to buy or sell stocks or other securities. A market order is an order an investor places with his broker to buy or sell stocks, bonds, or other securities as quickly as possible. Compared to other types of orders, such as limit orders or stop-loss orders, market orders are a good option for investors who are determined to buy or sell a security immediately.
Market orders are often great for investors who only trade very popular index funds, mutual funds, or stocks. That's because every stock and bond has a "buy" price - what buyers are willing to pay - and a "sell" price - what sellers are willing to offer the stock.
What is the difference between a market order and a limit order?
When you are ready to buy or sell a stock or fund, you have two main ways to determine the price you will trade: market orders and limit orders. The main difference between a market order and a limit order is that a market order triggers an immediate buy or sell off stock at the current market value, while a limit order allows you to delay the trade until the stock reaches a specified price.
This is the most fundamental difference between market and limit orders, but each type is better suited for specific trading situations. Here's what you need to consider.
Market orders: Make the trade now
The biggest pro of a market order is that your broker can execute it quickly because you tell the broker to take the best price available at the time. If you buy stock, a market order will be executed at whatever price the seller asks. If you are selling, a market order will be executed at the buyer's bid. The biggest con of a market order is that you cannot specify the transaction price. However, many times it doesn't matter. For large companies with high liquidity (block trades), the difference between a buyer's bid and a seller's ask -- called the bid-ask spread -- is usually just a cent or two. Unless you're buying a lot of stock, this difference doesn't matter.
However, if the price moves quickly, you may end up trading at a price that is very different from when you entered the order. It's rare but possible. More likely scenario: You enter a market order after the market closes and the company announces the news that affects its share price. If you don't cancel your order before the exchange opens the next day, you may end up trading at a much different price than you expected. Another potential downside is illiquid stocks, i.e. stocks with low trading volume. When you enter a market order, your stock price may spike or fall because there are not enough buyers or sellers to cover the order at that time. Since your order affects the market, you will end up with a much different price than before.
Limit orders: Make trade when the price is right
The biggest advantage of a limit order is that you can name your price, and if the stock reaches that price, the order may be executed. Sometimes the broker will even fulfil your order at a better price. Typically, you can set limit orders to execute up to three months after they are entered, which means you don't have to watch compulsively to get a price. On some (illiquid) stocks, the bid-ask spread can easily cover transaction costs. For example, if the spread is 10 cents and you buy 100 shares, a limit order at the lower bid price will save you $10, more than enough to cover the commissions of many top brokers. Biggest downside: You're not guaranteed to trade stocks. If the stock never reaches the limit price, the trade will not execute. Even if inventory reaches your limit, there may not be enough demand or supply to fulfil an order. This is more likely for small, illiquid stocks.
Hope this article helps you to know about market order and the differences between a market order and a limit order. Limit orders can help you save on commissions, especially on illiquid stocks that bounce around the bid and ask price. However, you can also save money by adopting a buy-and-hold mentality with your investments.
