Trillionaire Term of the Day - February 24, 2009 - Order Methods

Market Orders vs. Limit Orders

When placing an order to your broker to either buy or sell a stock, there are two main methods that you can use in order to complete the transaction.  A market order is a buy or sell order in which the broker will execute the order at the best possible market price currently available.  A limit order is an order to a broker to buy or sell a specified number of shares at a specified price.

For a market order, your stock order will automatically be matched up with the current market price.  Let’s say you want to buy 100 shares of McDonald’s (MCD).  If you place a market order to buy 100 shares, your order will be executed at the current market price at the time of the transaction.  While market orders are simple due to the fact that you allow the market prices to determine the price you will buy or sell the stock at, the problem with market orders is that you might not get the price you originally wanted when the transaction finally goes through.  Because stock prices rise and fall almost continuously, especially for very volatile and highly traded stocks, it often happens that you place an order to buy shares at a certain price, but in the few seconds after you placed your order, the stock price has either increased or decreased.  For example, if you placed your order to buy MCD when it was trading at $55 per share, and your order gets executed after MCD has jumped 50 cents to $55.50 per share, you will be forced to pay $55.50 per share instead of the desired $55.00.  While this might not sound like a big deal, if you are buying large amounts of shares, the 50 cent fluctuation can translate into a lot of money.   

A limit order is different than a market order, as it is an order to a broker to buy shares at or below a specified price or to sell shares at or above a specified price.  Let’s say you want to buy 100 shares of McDonald’s (MCD) at $53.00, but shares of MCD are currently trading at $54.95.  So, instead of patiently waiting and staring at your computer until the price falls to $53, you can simply put a limit order to buy 100 shares of MCD at $53.  Once MCD reaches $53, the transaction will automatically be executed and you will have 100 shares of MCD at $53.  Limit orders are great because they insure the price that you will buy and sell shares for, and you do not have to worry about a stock’s volatility when making a transaction.  The big downside for limit orders is the possibility that an order will never be executed.  For example, you if you really wanted MCD at $53 and it never fell to that level, you would never get your shares of MCD. 

Overall, limit orders are much better for investors than market orders.  Limit orders provide investors with a sense of certainty, and they allow investors to dictate the prices at which they want to buy and sell instead of having the market determine the prices for them.

 

Niki Pezeshki

College Trillionaire