Market Orders vs Limit Orders

Limit orders are different from market orders based on both the way they are executed and the cost involved. When most people think of "buying stock" or "selling stock," they are thinking of a market order. The investor simply tells the broker which security to trade and how much to buy or sell. The order is initiated at the current market price. The order is also initiated immediately. A limit order, on the other hand, is a more flexible order that can take place several days or weeks after the order is placed.

Market Order Example

Jean decides she would like to buy 10 shares of Stock X. It is currently listed at a market value of $3 per share. She calls her broker to initiate the market order. The broker begins the transaction by looking for a seller. Today, this all happens electronically, so the seller is located nearly instantaneously. Even though the market value of the shares is $3, the seller may have a separate asking price. The broker initiates the order at the asking price. Jean did not specify how much she wanted to pay; she only told her broker she wanted 10 shares.

Market Order Costs

Since the asking price and the market price of Stock X in the above example are different, Jean may not know how much the trade will actually cost. She thinks she is spending $30, but she may actually end up spending more if the asking price is higher than $3 per share. For example, the trade could occur at $3.50 a share, costing Jean $35 dollars. This expense can climb quickly with a high volume buy. If Stock X has a high trading volume, the asking price is more likely to be close to the market price. The broker's charge should be low with a market order.  

Limit Order Example

Jean decides she would like to sell Stock X, but she only wants to do so if she can earn $4 per share. If she issues a market order to sell, her broker would begin trying to sell the shares at the best price he or she could find. Instead, Jean issues a limit order to sell at $4 per share. Her broker will watch buy orders for the shares, and he or she will only sell if Jean can earn $4 per share on the transaction.

Limit Order Costs

Since limit orders involve a little more work from the broker, they are slightly more expensive trades. However, the investor is far more likely to get the exact anticipated results with a limit order than with a market order. Limit orders are particularly useful when the asking price of a stock is not known. Low volume stocks that rarely trade fall into this category. If Jean is a smart investor, she will use market orders when the stock is high volume and limit orders when the stock is low volume. This will keep her costs low and profits consistent with her expectations.

blog comments powered by Disqus
Scottrade