We get a lot of questions about when to use a limit order, and when to use a market order. These are two common types of orders you can place when you buy or sell a stock. It is crucial to know when to use each type of order in a given market scenario. If you use these order types incorrectly, you can potentially take larger than intended losses. We will start by defining them separately:
Market orders that are meant to immediately buy or sell shares of stock. If you are buying shares of a stock, you will immediately purchase shares of a stock at the market price, which is the lowest seller on the ask side of your Level 2.
If you are selling stock with a market order, you will immediately sell your shares to the highest bid in the market. If you need help visualizing it, here is a screenshot of a Level 2 with the bid orders on the left, and the ask orders on the right:
In the example above, a market sell order would will at $29.33. A market buy order would fill at $29.36.
A limit order sets the maximum or minimum price you are willing to sell a security. Unlike with a market order, you wait for a buyer or seller to buy or sell your shares at the price you chose. When you use limit orders, you actually get the opportunity to get ECN rebates, and lower your trading fees as a result. Learn more about how to get these rebates here.
Unlike with a market order, there is a chance your limit order may not fill immediately, or with the number of shares at your desired price. Since you have to wait for another participant to complete your order, you may have to be strategic about where you place limit orders if you looking to add liquidity. To increase the probability of getting your limit orders filled, put your limit sells when a stock is uptrending, and put your buy limits when the stock is dipping.
When to Use a Market vs Limit Order
In general, you want to use limit orders for the majority of your trade executions. Using market orders on liquid stocks like Apple, Microsoft, etc will not have any significant consequences since there is a huge market of buyers and sellers in these names. However, on more illiquid names with larger spreads, they can result in you losing a lot of money through slippage.
Slippage is when there is a difference between the expected price of a trade and the price at which the trade is actually executed. It is common to get slippage on more illiquid stocks when using market orders, as there are fewer buyers and sellers willing to buy or sell your shares at the price you want to. The only time you may want to use market orders are for stop-loss orders on stocks you are not watching every tick, for a swing trade for example. Market orders ensure you will completely exit your position when it hits your stop price.
If you use a limit stop order, you run the risk of not exiting your position fully, and the market going against you further with the portion of your position that didn’t get executed. If you are a swing trader who puts hard stop losses in and does not have time to watch the market often, you will want to use a market stop order.
Let’s say you want to buy Apple stock. It is currently trading at $180 share. If you use a market order to buy, you will get filled at $180 a share, assuming that’s where the ask price is trading. If you use a limit order, you can potentially get filled at a lower price instead of taking the ask price. You also make sure that you get filled ONLY at the price you specify. If you use a market order, especially on large position, you may fill some of your sell order at higher prices. This is very likely to occur if you are trading a stock with less liquidity. Let’s say you are trying to sell 1000 shares of STNE, which only trades a couple of million shares a day on average.
Let’s say you place a market order to sell at $35. If there is only a 500 share bidder at that price, you will not fill your whole position, and the order will go to a lower bidder to fill the rest of the order. Let’s say the next bidder that is able to fill your order is at $34.90. This means that your average sell price was $34.95 instead of 35, since you sold 500 shares at $35 and #34.90. This costs you an extra $50 to exit (sometimes the slippage can be WAY worse).
There are typically 5-10 cent spreads on this stock as well. So in addition to the slippage, if you market order to sell you will be losing an extra $100 from the spread as well. The market order essentially cost you an extra $150. A well placed limit order would have avoided all of these unnecessary costs.
You want to use limit orders to complete the majority of the orders you place to buy and sell stocks. The only time you should consider using s market order is for a stop loss order. If you still have any confusion about these concepts, feel free to fill out our free trading consultation below.