Understanding Trading Orders: Market Versus Limit

When placing an order to purchase or sell underlying stocks, there are two distinct orders that can be executed, namely: 

1. Market order: This is executed swiftly at the market price at any given time.
2. Limit order: An order which is set at a predetermined price for the purchase or sale of stocks. 

It is possible to engage in negotiations when buying stock. Naturally, one can simply buy the stock at the set price right from the get-go. However, as a buyer you can also attempt to hammer out a better price with the seller and hold your ground by not purchasing the asset unless your demand pertaining to price is met. 

Bearing this in mind, traders who enact market orders are less concerned about the price and more concerned about the speed at which orders are executed in order to buy stocks. On the other hand, traders who have price specifications in mind rather than the time-sensitivity of orders, will enact limit orders. 

The Workings of Market Orders 

In theory, a market order is the simplest form of buying and selling of securities online. A market order will push through a trade at the given market price once the order is processed by an online trading platform or broker. 

For the sake of understanding, let’s take a look at an example. If an investor comes across 10 shares and enters an order ‘at the market’, then the sale of these shares will be processed at the amount that it is currently trading at. Although this seems rather straightforward and the chances of such orders being completed are much higher than limit orders, there are a couple of factors to take note of before you get started. 

Firstly, stocks need to be available in order for the sale of these stocks to be processed. This depends on a further subset of factors such as the liquidity of stocks and the timing of relevant orders on the market. 

Secondly, orders placed on the stock market are processed according to the priority of the order in question. Large orders tend to take a lot longer to be completed than smaller orders while these bigger orders may have the capacity to shift the overall market noticeably. Any major fluctuations due to big market orders might lead to the suspension of the sale of stock, thus stopping you from buying or selling for a period of time.

Lastly, if you trade outside of the normal trading hours, then the market order will be filled and processed based on the trading price which is determined at the start of the next trading day. 

Assessing Limit Orders

Limit orders, which have a wider framework which includes time and price considerations, have been crafted to ensure that traders have more control. This extends to the actual price at which stocks are bought or sold on the market. But, as you’ll note, there is a minimum price threshold that is included with all sales orders. Plus, before any purchase can be made, a maximum price must be selected by the potential buyer to complete the price band. 

Utilizing a limit order is a good option when dealing with highly-volatile assets or assets which aren’t frequently traded. Furthermore, assets with converging bid-ask spreads (highest price a buyer and lowest price a seller will accept) are usually traded by implementing limit orders. Ultimately, the use of limit orders ensures that the maximum price that any individual is willing to pay for a stock or financial asset is taken into account before a transaction takes place. 

Example of a limit order 

Let’s assume that an investor wants to purchase stocks at a price of $60 but the price at the start of the respective stock is $65 – which is too high for the investor. A limit order can be implemented at a price of $60, and if the price of the stock happens to drop to that amount or less, the limit order will be executed and trade finalized at the lower price. 

Limit orders, though, have the tendency not to be fulfilled as many times the actual price does not drop as low as the maximum price a buyer is willing to pay. In these instances, the trade will not take place and the investor will be left without any of the underlying stocks. 

In addition, bid-ask spread also has a bearing on whether limit orders are put into motion. Both the asking price and bidding price must be met, given the trader’s predetermined price, for the limit order to be fulfilled.