This one is going to be extremely straightforward. Let’s go over two of the most common order types one might use to execute a trade, and some pros and cons of each.
Simply put, placing a market order to buy a stock will execute the trade as soon as possible at the best (lowest) possible price available. In most cases, the trade will be executed very close to (or at) the current stock price. The same goes for selling shares that you already own with a market order, they will be sold as soon as possible at the highest available price.
In the words of Investopedia (this Investopedia article does an extremely good job explaining order types if you aren’t impressed with my article):
“Market orders do not guarantee a price, but they do guarantee the order’s immediate execution.” – Investopedia
Fast order execution.
Can execute at a price that is worse than intended (more on that below).
In many cases, particularly with popular high volume stocks, there are an insane number of trades that take place every day. As an example, Apple ($AAPL) stock saw over 173 million shares exchange hands on 11/30/21. That many shares traded in just one day.
If you were trying to sell a share of Apple today, the odds of someone with an open order that is waiting to be filled for an equal or better price per share are extremely high, and a market order would almost certainly be filled immediately.
Now, this can be a problem if we are trading the shares of a very small company with low trading volume.
For example, and I will preface this by saying that this example is extremely dramatic for demonstration’s sake, let’s say company XYZ has hardly any trading volume and their stock is currently trading at $5 per share.
If someone else places a limit order ( more on that below) to buy a share of XYZ stock at $1 per share, and you are the only other person in the world selling 1 share of XYZ stock. If you place a market order to sell your share, it will execute at $1 / share and you will lose 80% (vs. the current price) of your investment in a matter of seconds.
How do we prevent this?
Simply put, a limit order involves specifying the best possible price you are willing to pay for a trade to execute. If you are buying, you specify the highest price you are willing to pay. If you are selling, you indicate the lowest value you are willing to receive per share. The order will only execute at this specified price or better; if a better price is available.
Your trade will only execute at your limit price or better.
If the price you specify is worse than the current price / share (higher if you are buying and lower if you are selling) your order may not execute.
Lazy of me to say, but these require more effort than market orders.
Personally, I use limit orders more often than I use market orders. I like to know the price my trade will execute at. When I say they require more effort, I am referring to manually typing in the price. It is actually very easy and takes hardly any time, but it is just slightly more effort than simply placing a market order.
An Important Distinction
There are a few additional options you have when placing a trade that I have not yet mentioned. With a market order, these only apply if there are 0 people on the other side of the trade you are trying to make (uncommon with many stocks). With a limit order, these can apply if your specified trade price is never reached.
If an order does not immediately execute, it will either stay open and try to execute until the end of the trading day (4pm eastern on days that aren’t holidays), or it will stay open indefinitely until you manually cancel it (or it gets executed).
You make this choice when placing the trade. If you have done your research and are certain you want the trade to be placed at your specified price (if placing a limit order), leaving to order GTC (good till cancelled) usually makes sense.
Both market and limit orders have their uses, but unless the company you are buying / selling has a high volume of trading, limit orders can often prevent an unexpectedly bad trading price. Then again, if you are buying and holding for the long term after doing your research, the difference of a few pennies per share probably won’t make or break you.
I hope you found this helpful! Please do not hesitate to reach out to me with any questions, comments, or suggestions!