Roger Wohlner is a writer and financial advisor with over 20 years of financial services experience. He writes about financial planning for Wealthsimple and for a number of financial advisors. His work has been published in Investopedia, Yahoo! Finance, The Motley Fool, Money.com, US News among other publications. Roger owns his own finance blog called 'The Chicago Financial Planner'. He holds an MBA from Marquette University and a Bachelor’s degree with an emphasis on finance from the University of Wisconsin-Oshkosh.
When investors are looking to buy or sell securities traded on a stock exchange, they do so by placing an order to buy or sell the shares of the stock, ETF, closed-end fund, or other exchange-traded security. There are a number of different types of orders that can be used. Two common types of orders are the market order and the limit order.
How market orders work
A market order is typically submitted by the investor online via the site of the firm at which they hold their account. Market orders can be submitted to a broker or a trading desk as well. (The transaction fees will generally be higher for these trades.) The order to trade the security is executed at the current market price when the trade order reaches the exchange.
For widely traded securities such as large cap stocks and widely traded ETFs, the market order will be executed almost instantaneously because these securities are very liquid and there is constant demand among buyers and sellers. The bid/ask spread, which represents the difference between the highest price that a buyer is willing to pay for the security and the lowest price that a seller of the security is willing to accept, is usually very narrow for these widely traded securities.
Exceptions include some small cap stocks and closed-end mutual funds. In this case the bid/ask spread is often wider than for more widely traded securities. What this means for investors is that the price that the trade is executed at might differ from the price that is indicated at the time a market order is placed. In the case of an investor looking to sell a security, the price they receive with a market order might differ widely from the price indicated at the time they placed the sell order—the price may well be significantly lower than what they were expecting to receive.
How limit orders work
A limit order is an order to buy or sell a security at a specified price. A limit order connected with a sell transaction will only be executed at the limit price or higher. A limit order for a buy transaction will only be executed at the limit price or lower.
Using a limit order allows investors to gain a level of control over the price at which their trades are executed.
When looking to buy a stock, a limit order can be set at a level that the investor believes is a good price for the stock. For example, at the time of this writing shares of Apple’s stock stood at about $204 per share. If the investor feels that this price is too high but would be willing to buy shares if the price fell to $190 per share, they can set a limit order to buy a specified number of shares should the price fall to $190 or below. The limit order ensures that the trade will not be executed at a price higher than $190 per share in this case.
Say an investor owns the stock and feels that $220 per share would represent a price at which they’d like to sell some or all of their shares they can set a limit order at $220 that would trigger the sale of the specified number of shares. Again, the shares will not be sold at a price lower than $220 per share in this case.
Limit orders are often placed on a “good ‘til cancelled” basis meaning they remain in place until the order is filled or until it is cancelled. A limit order can also be placed as a day order, meaning that it expires at the end of the current trading day if it is not filled.
A variation of the limit order is a stop-limit order. This is a combination of the stop order and a limit orde. This type of order triggers the buy or sell transaction when the market price of the security moves past the stop order price. The stop order will be filled once the stop price is triggered regardless of where the actual market price is when the order is filled. This can be an issue if the stop order was placed as downside protection on the price of a holding and the stock market is rapidly declining. A stop order triggers a market order that is executed at the next available price. If the price of the security is declining rapidly, the price at which the trade is executed could be lower than expected. There is no lower end limit on the ultimate price at which the order is executed. The stop-limit order will not be executed if the stop order is not triggered. Additionally, the order will not be executed if the next price after the stop portion of the order is outside of the limit portion of the order. The main benefit of a stop-limit order is that it provides an investor with more control over the price at which their trade is executed.
Market versus limit order
There are a number of differences between a market order and limit order.
A market order is filled at the next available price for the security. Once the order is submitted, investors have no control over the actual price at which the order is filled. On an average day in the markets, a market order for a widely traded security will typically fill quickly and at a price that is close to the price in place at the time the trade order was submitted. This may not be the case for securities that are thinly traded or in a rapidly moving (up or down) stock market environment. With a market order, investors are at the mercy of the market to determine the ultimate price at which their trade is executed.
A limit order provides a degree of control for investors in that it sets a lower limit in the case of a sell order, and an upper limit in the case of a buy order**,** over the price at which the trade can be executed. This can help ensure that the investor doesn’t pay a higher price than desired to purchase shares of the security, or that the trade isn’t executed at a lower price than that at which the investor desires to sell the shares.