A market order buys or sells a stock at whatever the going price is currently, while a limit order makes the trade when a stock hits a price you’ve specified. Which type to use also depends on the situation. So here’s what you need to know about the market order and the limit order and when it’s best to use each one.
Understanding market and limit orders
Market order
The market order is the most common and basic order type. Placing a market order allows you to buy or sell a stock immediately at its current market price. If you are buying a stock, the order will execute at the seller’s asking price. If you are selling a stock, the order will execute at the buyer’s bid price.
One advantage of placing a market order is that as long as there are willing buyers and sellers, your order is almost guaranteed to be executed. The disadvantage of a market order is that the execution price is not guaranteed. That said, unless you are trading volatile stocks such as penny stocks, market orders usually execute at or around the ask price (when you are buying) or bid price (when you are selling).
Many brokers automatically default to using a market order unless you specify otherwise. If you want to buy or sell a stock at a specific price, that’s where the limit order comes in.
Limit order
A limit order allows you to buy or sell a stock at a specific price or better. When buying a stock, a buy limit order only executes at the limit price or lower. When selling a stock, a sell limit order only executes at the limit price or higher.
For example, say you want to buy a share of XYZ stock for no more than $25. In this case, you could submit a buy limit order for $25 and your order will only execute if the price of XYZ stock is $25 or lower. Alternatively, if you want to sell a share of XYZ stock for no less than $25, you could submit a sell limit order for $25 and your order will only execute if the price of XYZ stock is $25 or higher.
Unlike a market order, a limit order is not guaranteed to be executed. A limit order can only be filled if the stock’s market price reaches the limit price.
So how do you know when to use a market order or limit order?
For many investors, market orders are good enough. If you want to own shares of a company sooner rather than later and you’re comfortable paying a price near where it’s currently trading, a market order is likely your best option. Paying a few cents or a few dollars more or less likely won’t matter much to you if you plan on holding the stock for a long time.
Because stock prices can change quickly — especially in fast-moving markets or with low-volume stocks where there is a large difference between the price a buyer is willing to pay (bid price) and the price a seller will accept (ask price) — the price at which your market order executes might deviate a bit from the price you were quoted. With volatile stocks, this can be drastically higher or lower than the price you wanted to pay. In this case, a limit order can better protect the price you’ll pay for a stock.
When you might want to use a market order
- Your main goal is to buy or sell shares immediately.
- You don’t care as much about the specific price at which you buy or sell a share.
- You’re trading a stable stock with high volume and a narrow spread between the bid and ask price.
Buyers and sellers use limit orders for several reasons. A limit order can be used to protect a buyer from sudden spikes in stock prices. Whereas the execution price on a market order can sometimes fluctuate drastically after placing your order, a limit order allows you to set a predetermined price for what you are willing to pay for a stock.
In addition, you might use a limit order if you want to own a stock that you feel is currently overvalued or sell a stock that you feel is currently undervalued. You can set a limit order for the price you’re willing to pay or sell, and if the share price reaches it, your order will be executed. Whether buying or selling stock, limit orders are a great way to protect from sudden fluctuations in stock prices.
When you might want to use a limit order
- You prefer to buy or sell shares at a specified price or better.
- You care more about getting the right price than you do the speed the order executes.
- You want to own a certain stock that you feel is currently overvalued.
- You want to sell a certain stock that you feel is currently undervalued.
Alternatives to market and limit orders
Although the market or limit order are the two main types of orders, buyers and sellers have a few other options when trading stocks:
- Stop order (or stop-loss order). A stop order, or stop-loss order, is an order to buy or sell a stock at the next available price if the price reaches or exceeds a specified level. Once the stop price is reached, a stop order becomes a market order and executes at the next available price. Because it becomes a market order, the execution price can still fluctuate.
- Stop-limit order. A stop-limit order combines the features of a stop order and limit order. Once the stop price is reached, a stop-limit order becomes a limit order that executes at a specified price or better. This gives you better control over the price at which the order can be executed.
- Trailing stop. A trailing stop order is an order to buy or sell a stock that automatically adjusts the stop price at either a defined percentage or dollar amount above or below the current market price. As the market price rises or falls, the stop price rises or falls by the trail amount. However, if the stock price moves in an unfavorable direction, the trailing stop price doesn’t change, and hitting the trailing stop price triggers a market order.
The key to any order is to have an account with a broker that will execute your order in a timely fashion.
Market orders and limit orders are the two most common order types, so they’ll likely be your go-to as you get started trading stocks. And these two order types are great for most beginner investors. As you become more experienced, you might decide to incorporate some of the other order types into your trading strategy.
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