Photo: Flickr user Francisco Gonzalez.
This article was originally published on November 21, 2014. It was updated on August 4, 2016.
You know about all the different kinds of orders that you can place with your broker, right? There's "Speak up, please," for example, if you're dealing with a soft-spoken broker. And if a strange broker calls you up at dinnertime to urge you to buy a terrific stock that's sure to make you a lot of money (this is a "cold call"), the best order to place is, "Get lost!"
But for average investors like us, there are two key kinds of orders we need to understand when we trade stocks: market orders and limit orders.
When you place a market order, you're essentially asking your broker to buy or sell a given security as soon as possible, at the best available price. This is the most common kind of order, and it's the simplest, too.
With a limit order, you make clear your intent to buy this or that stock, but only at a certain -- or better -- price. So if you place a limit order to buy 50 shares of Home Surgery Kits Co. (ticker: OUCHH) at $45, and the stock is trading around $48, your order won't be filled until or unless the stock falls to $45 or lower.
Market or limit -- which should you use?
For many trades, market orders are good enough. If you know you want to own shares of a certain company fairly soon, it's trading at a price you're comfortable with, and it's not a very volatile stock, a market order should serve you well. For most folks, if their trade is executed at a price that's a bit above or below what they expected, it's not likely to be a big deal -- especially if they aim to hang on for a long time and hope to enjoy substantial share-price appreciation. (For active traders aiming to hold the stock for only a brief time, small differences can matter a lot more. We don't advocate such a style, though.)
You might use a limit order if you want to own a certain stock but think it's overvalued now. If so, you could set a lower "limit" at which you'll buy. If it reaches that limit, the order will be activated, and you'll buy the stock. If not, your order will expire unfilled.
One of the downsides of limit orders is that sometimes you just don't get into -- our out of -- the stock you wanted because your desired price didn't materialize in time. You can always place a new limit order, though, or switch to a market order. For those who really wanted to buy a stock as it began or continued a long ascent, limit orders have proven regrettable.
They are especially advisable, though, with stocks that are volatile or have wide bid-ask spreads. The spread is the difference between the bid and ask prices for a stock -- respectively, the highest price that buyers are willing to pay for a stock and the lowest price at which they're willing to sell it. With a market order for a volatile stock, you might be unpleasantly surprised to find that you bought at a much higher price, or sold at a much lower price, than you had expected.
Photo: Insider Monkey via Flickr.
A range of opinions
Ask different investors, though, and you'll get different perspectives. Some years ago, on our Investing Beginners discussion board, some Fool Community members responded to a good question that someone asked: "I am new to investing... should I place a market or limit order?"
ImAGolfer said:
I'm sure you will receive several different opinions on this, but my experience shows I missed a great buying opportunity one time when I used a limit order. Additionally, limit orders usually have a higher transaction fee. On the other hand, when selling, I've used limit orders to my benefit. I was not in a hurry for the proceeds of the transaction, so the order just sat there till it executed and it worked great. I guess it depends on your situation.
Jbking offered a good clarifying question: "I think you have to ask yourself which is more important: to ensure the price or to ensure the execution? Is part of your strategy to buy stock ABC at a specific price or better, or will you pay a sky-high price for the alleged good stock?" He also offered a downside to market orders: "If you place a market order when the market is closed, you could get hit by the possible gap when the stock opens, ya know?"
bogwan offered a simple rule: "If you are buying a [big blue-chip stock], then market is the way to go. If you are buying a small-cap that trades only a few shares a day, then put in a limit or you might get a really bad price."
This is worth considering. Look up some stocks that interest you and see how much their prices varied during the last trading day -- that will give you an idea of their volatility. For example, on a recent day, Procter & Gamble stock traded between $85.80 and $86.52 per share, and The Home Depot traded between $135.46 and $137.20. TripAdvisor stock, meanwhile, was a bit more volatile, trading between $62.69 and $66.07 per share. Any stock can experience a huge price swing if there's some big news or development, but blue-chip behemoths tend to be steadier than most. (On the day that I looked, First Solar happened to have dropped 11% after issuing weak projections.)
Note, too, that during trading hours, few major stocks will surge or plunge from minute to minute, so market orders are generally safe. Overnight, though, anything can happen.
Learn more
As you learn more about investing, be sure to learn more about brokerages, too, and how they work. Doing so can help you use them more effectively. Our Broker Center, featuring easy-to-compare details on many respected brokerages, is a great place to start. Many brokers charge the same fee for both market and limit orders.