Market Orders Vs. Limit Orders: The Significance, The Similarities, And Differences
Stock trading is the simplest way to earn money in the US. All you need to do is to select the right stock broker, open an account, load it with cash, and start buying and selling stocks.
However, making money from the stock markets is easier said than done. Millions of traders try their luck every day, but not everyone ends the day with a heavier wallet.
Ask any successful trader what it takes to generate healthy profits in the market, and they would happily say, ‘Knowledge.’ The right knowledge can make the difference between profit and loss
In our endeavor to make the stock market a better place for beginners, we take up topics that simplify complex technical jargon that perplex almost all amateur traders.
This article takes up the two most popular order types, market order and limit order, and tells you the reasons that make these order types the most important and frequently used.
But before going any further, let us understand the role of the bid and ask prices in the market and limit orders.
What are the Bid and Ask Prices?
The bid price is the highest price at which buyers are willing to buy a stock. Ask price is the lowest price at which sellers are willing to sell a stock.
Generally, the ask price is always higher than the bid price, and the difference between the ask price and the bid price is known as the spread.
Bid and ask prices play an important role in determining the entry to and the exit from a stock. For example, if the difference between the bid and ask price is less than 10 cents, then the script is a liquid one, which means you can get in and get out anytime you wish to.
If, however, the difference is more than 50 cents, then the stock is most likely illiquid, and you might not get a seller or a buyer when you wish to buy or sell the stock.
What are Market Orders?
Market order refers to an order that gets executed at the current bid or ask price. Market orders can be both buy and sell orders.
If you wish to buy a stock, the exchange generally executes the order near the current ask price. If you wish to sell a stock, the exchange will most likely the order near the current bid price
If the spread for a particular stock is large, then there can be a wide disparity between the price at which the order is placed and the price at which the order gets executed.
What are Limit Orders?
Like market orders, limit orders can be both buy and sell orders. The buy limit order refers to an order that you may place below the current market price (CMP). Similarly, a sell limit order can be placed above the CMP.
In case of a buy limit order, the order will get filled if there is a seller available at the price you wish to buy the stock. Likewise, for a sell limit order to get filled, there has to be a buyer willing to buy the stock.
Why Do You Need to Know About Market and Limit Orders?
Market and limit orders are the two most frequently used order types in the market. While there are sub-types of market and limit orders, like the stop-loss market, stop limit, and the likes, traders mostly use market and limit orders for all their transactions.
The market order can suit you more if you want to buy or sell a stock without waiting for the price to reach a predefined level. While this can be good for stocks with much larger volumes with a narrow spread, it can make all the difference between profit and loss in case the stock is an illiquid one.
A market order can be good for you if you are trading on a low capital, want quick execution, or are trading a highly liquid stock.
The limit order is the most preferred order type for most investors and traders, as it allows them to trade with a price in mind. However, there is no guarantee that the stock will reach the limit price before your target time. Sometimes, even when the stock reaches the target price, the order does not get executed, due to the non-availability of demand or supply.
Market Order and Limit Order – The Differences
While in essence, both market and limit orders are meant to buy or sell stocks, there are some intrinsic differences between the two.
The following are the major differences between market and limit orders
a. Market orders are instantly executable orders; limit orders can be deferred until the stock reaches the intended price.
b. Market orders cannot be placed beyond trading hours; limit orders can be placed before or after the market closes, although the order will hit the market when it reopens the next day.
c. Market orders are subject to market fluctuations; limit orders are generally not subject to fluctuations, as the order gets executed when the stock reaches the target price.
d. Unlike a market order, a limit order has to be placed below the CMP (for a buy order) or above the CMP (for a sell order). In case you do not follow the rule, the order might be treated as a market order and executed immediately.
e. Unlike a market order, a limit order requires you to enter a trigger price. The broker submits the order to the exchange when the stock price touches the trigger price.
f. Unlike a market order, you can use the limit order for setting a stop loss.
g. Generally, a few full-service brokers charge higher fees for limit orders. By opening a trading account with a commission-free broker, you can avoid worrying about the different charges.
Market Order and Limit Order – The Similarities
While the differences far outweigh the similarities, some things are alike with the market and limit orders.
The following are a few similarities between market and limit orders:
a. Both are placed to buy or sell a stock.
b. The execution, in both cases, depends on the availability of the stock, its liquidity, order size, order time, and the condition of the market.
c. Both orders do not work in a situation where the stock price has hit an upper or lower circuit.
While the knowledge about market and limit orders can set you off to a good start, by knowing more about time in force, you can scale up your trading skills.
In the stock market, no amount of knowledge is sufficient to make you an expert trader. However, the more you read, the fewer mistakes you will make. And, in the market, not losing your capital is more important than making profits.