Market Order - Explained
What is a Market Order?
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Table of ContentsWhat is a Market Order?How Does a Market Order Work?How do you Place a Market Order?What is the Right Moment to use Market Order?Why market order may not be the BestMarket Order Versus Limit OrderSummary
What is a Market Order?
A market order refers to an instruction to buy or sell a security immediately (at the current price). A market order does guarantee execution. However, it does not guarantee the price at which it will be sold. The execution usually happens either at the current price or near the current price. When a sell order is immediately processed and you are willing to transact at the current market price, then this transaction becomes a market order. A market order is considered the most reliable and quickest means of getting in or exiting a trade. The best part about market order is that there are high chances that your order will be successfully executed. It is preferred because it enhances trade, especially where execution to sell or buy is of much concern than the current bidding price. A market order can be divided among various participants on one part of the transaction. This then results in different prices of shares. In general, this order is the most basic hence making it generate the lowest commissions.
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How Does a Market Order Work?
For instance, when you are selling shares of your ABC stock, a broker will get into the trade as a market order and then will purchase ABC at a price currently on offer. Note that when orders are received, they are assigned the best price offers. In case there is an order which has been assigned the highest bid price coming in, then it is automatically placed at the top since it the highest bid price. Generally, when there is a market order being received, it is assigned either the highest or the lowest price. In other words, when a trader places a market order to purchase a stock, he or she will pay the highest market price. On the other hand, if a market sell order is submitted, then the selling will be at the lowest price in the market.
How do you Place a Market Order?
By placing a market order, you are basically agreeing to purchase the stock without considering the price at which the stock is trading. Your main concern is to get the stocks regardless of their current trading price. Lets say you are using an online broker to enter your order. In this case, the order will appear on the screen. Where there is an active stock trading, there will be an instant filling of that particular market order. Nonetheless, if in that particular stock there is unusually high volume, then it will take time for the market order to be filled. Note that in a market where there is fast movement of stock, there are high chances of purchasing the stock without the price changing. Meaning that the price at which you place your order is the same price that you will pay to receive your order. However, in most cases, the purchasing or selling price will always be close to what you saw when placing your market order. Where there is a high market activity of a given stock, your order to sell will be less or your order to buy will be more. Also, where there are other market orders placed before yours, there is bound to be a drastic change in the stock's price and you might not receive or pay what you intended when you entered your market order.
What is the Right Moment to use Market Order?
Market orders are suitable when trading in securities in high volumes. This means that there is rapid fill in such kind of security. Examples of such securities may include:
- Large-cap stocks
- Future or ETFs
This is contrary to those stocks with average daily volume (low floats). Such stocks are thinly traded making the bid-ask spreads to be a bit wide. For this reason, market orders for such securities take time to be filled, and also at an unanticipated price. This means that you are able to fill the securities at significant trading costs. In general, Market order may be a solution, especially where the market is not moving in your favor. You can use a market order to bail yourself out fast without worrying about the current selling price. It is true that most investors will want to control both market entry prices as well as the exit prices. However, there are situations that will necessitate an investor to quickly buy or sell the stock without even minding their current market price even if it means incurring a little loss in the process.
Why market order may not be the Best
A market order in itself is a practice that raises questions. It is, therefore, advisable to avoid it at all costs. This is because market orders will make you pay the highest prices or sell at the lowest price. In addition, you will also incur some slippage costs. Slippage cost refers to the costs you incur when the maker of the market happens to change the spread, a process that only benefits him when it comes to market orders. All these are costly to an investor making it not worthwhile.
Market Order Versus Limit Order
As discussed before, a market order is where security is either purchased or sold almost immediately they enter the market without putting into consideration the current price. With limit orders, you simply place an order to either sell or purchase a security at a price which is not above or below the set price. Unlike market orders where investors do not have control over the price, limit order does give investors powers to determine the trading prices in the market. When it comes to limit orders, buying limit order can only take place at the limit price or lower, while selling a limit order can take place at either limit price or higher. For instance, lets assume that you want to buy shares of XYZ stock at a price not exceeding $20. In this case, you will submit this amounts limit order and the buying will only take place if the XYZs stock is selling at $20 or lower. A limit order is necessary where an investor is more concerned about the price than the execution. It is, therefore, suitable for investors looking to execute buying or selling of securities at favorable or better prices. However, it is worth to note that with this kind of orders, the execution chances are very slim.
It is true that market orders do offer high chances of execution of a trade. But it is important to keep in mind that they do not offer a 100% guarantee that the orders placed will go through. This is because all transactions in the stock market depend on stocks availability. Also, stocks vary depending on the timing, stock liquidity, as well as the size of the order. All these may significantly reduce the chances of a trade being executed.