Market Order vs. Limit Order: When to Use Them

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Bulls on Wall Street

One of the most common questions we get from new traders when they first start a platform is:

“How do I actually execute an order and place a trade?”

There are several types of orders in trading that you need to be aware of when placing a trade. To take a long or short position, the two most common and useful order types you will see on any platform are limit and market orders.

It is critical that you understand the differences between these two orders and know exactly when to use one or the other. Making the wrong choice at the wrong time can create a lot of headaches and potentially some dangerous losses, so make sure you study and practice these two types before diving into live trading.

Let’s take a look at what each type of order is and when to use it.

The basics of market orders

A market order is the fastest way to enter a stock. When you place a market order, it will be filled almost immediately at the nearest Level 2 bid or ask price. It ensures that you get into the trade, but there is no pre-set price that you will enter. You buy / sell the stock at the best available price point in the market. These types of orders are great to use when you need to execute a trade right away and are okay with potentially some slippage.

When you buy shares of a stock, you are immediately buying shares of a stock at the market price, which is the lowest seller on the ask side of your level 2. When you sell stocks with a market order, you are immediately selling your stocks for the highest bid in the market.

Check out this screenshot of a Level 2 screen below. The ‘bid’ orders are on the left and the ask orders are on the right.

If you wanted to buy the above stock and place a market order, you would be directly executed at the best price on demand, which at that point is $ 20.48. If you want to sell the above stocks and place a market order, you will be directly filled at the best price of the bid of $ 20.47

When to use market orders

When a trade requires fast execution, market orders can give you an edge over limit orders. You only want to use market orders for highly liquid stocks with tight spreads to avoid slippage, which we will get into in the next section. If you use market orders on liquid stocks that are high in volume and relatively stable, you will not get bad orders.

Another great time to use market orders is with your stops during swing trades. Using Market Orders for Stop loss orders Swing trading ensures that when it reaches your stop price, you will completely exit your position. This is great when you’re not watching every tick and just stop trading and walk away.

If you use a limit stop order, you run the risk that you will not leave your position entirely and that the market will continue to move against you with the part of your position that was not executed. If you are a swing trader who uses hard stop loss and doesn’t often have time to watch the market, consider using a market stop order.

The disadvantages of market orders

As mentioned earlier, market orders don’t set a price at which you want to enter the position. That leaves room for ‘slip’. Slippage occurs when there is a difference between the expected price of a trade and the price at which the trade is actually executed. Slippage often occurs with illiquid stocks when market orders are used as fewer buyers and sellers are willing to buy or sell your stocks at the level 2 price you want.

The stock’s “spread” (the difference between the best ask and the best money) can be quite large, and you will be filled far from the current trading price. If you use a market order, especially with a large position, you can also fill part of your position at higher prices as it “eats” its way through the current bid or ask offer until all of your stocks are filled. This is very likely when you are trading a stock with low liquidity, low volume.

The basics of limit orders

If you want to be precise with your entries / exits, limit orders are the way to go. A limit order sets the maximum or minimum price that you are willing to buy or sell a stock. Unlike a market order, you wait for someone to buy or sell your shares at the price you choose.

For example, if you specify a buy limit order of $ 25.50, it means that you will ONLY execute the trade at a price of $ 25.50 or below. On the flip side, if you sell or short a stock with a sell limit of $ 23.00, you will only be filled at a price of $ 23.00 or more. The price you set for your limit order is exactly what, the limit or maximum price, either way, that you are ready to buy or sell a stock for.

When to use limit orders

In general, you want to use limit orders for most of your trade executions. Using market orders for liquid stocks like Apple, Microsoft, etc. will not have material consequences as there is a huge market of buyers and sellers for these names. However, with more illiquid names with larger spreads, they can cause you to lose a lot of money on slippage.

Then limit orders come in handy as you can specify the exact price at which you want to be executed. Limit orders are also great for triggering important levels of support and resistance in swing trades when you can’t be in front of the screens all the time. For example, if you want to buy a stock on a drop to $ 25.00 for a multi-day swing, you can place a buy limit at $ 25.00 and as long as the order is open, you will be executed even when you are away from your desk.

The disadvantages of limit orders

As already mentioned, market orders are executed almost instantly. With limit orders, there is a chance that they will not be executed because you are quoting a certain price that the stock may never reach. For example, if a stock is trading at $ 27.00 and you try to buy it with a limit order at $ 25.00, the stock can never fall to $ 25.00 and meet your limit order.

In the case of limit orders, there is also the possibility that your position will be “partially filled”, ie the order has only fulfilled part of the proportions you requested. Since you technically have to wait for another market participant to complete your order, you may need to be strategic about where to place limit orders if you want to add liquidity. To increase the likelihood of your limit orders being filled, place your sell limit when a stock is trending up and your buy limit when a stock is falling.

example

Let’s say you want to buy Apple stock and it is currently trading at $ 140 per share, with a bid of $ 139.95 and a demand of $ 140.05

Now, if you use a market order to buy, you will be executed at $ 140.05 per share, assuming it’s fairly liquid and has a tight spread at the moment.

When using a limit order, instead of taking the best price on the ask ($ 140.05) as with the market order, you may be able to get executed at a lower price. Let’s say $ 140.05 is just too much for you, and you want to buy exactly $ 139.97. You can then use a buy limit of $ 139.97 and if someone is willing to sell you their stock at that price they will fill you in.

summary

In most cases, you’ll want to use limit orders to complete the majority of orders to buy and sell stocks. The only time you should consider using a market order is with a stop loss order or when you are trading a highly liquid name with a small spread. If you are still confused about these concepts, feel free to apply for our live trading bootcamp below!

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