Market and limit orders are the two most common ways investors can purchase a stock.
When you understand the use of market and limit orders, you can improve the profitability of your stock investments.
By and large, most investors place one of two types of orders when buying stocks: “market orders” and “limit orders.”
1. Market orders: A market order is an order to buy or sell a specific number of shares at the best price available when you place your order. Market orders are almost always filled within a very short period of time—minutes or even seconds. Still, you only learn the price you paid (for a purchase) or received (for a sale) after the order is filled. There is always the possibility that the market price may change, for or against you, between the time you place the order and the time it is filled.
2. Limit orders: A limit order specifies the highest price you are willing to pay for a stock. The main risk here is that your order will go unfilled if there is no stock available at or below your price. This introduces a filtering mechanism that can cost you money, especially if you set your limit below the current market price.
10 Stocks to Buy and Hold Forever
If you have six or seven of these stocks in your portfolio, you should be pleased. These are stocks that have staying power. These are companies that can withstand market setbacks—they pay dividends, for one thing—and they’re usually first to move up when the market recovers.
This can create an unfortunate dilemma: an unfilled order is much more likely with your best choices, since they are far more likely to shoot up faster than you guessed. But you’ll always get a fill on your worst choices; they’ll come down to meet your price, then go lower.
Let trading volumes help you decide between market and limit orders
Most investors should use market orders when buying or selling widely traded shares. That’s because the market-order risk of occasionally paying too much is more than offset by the limit-order risk of missing out on your best ideas.
Use caution when you invest in thin-trading shares. Thinly traded stocks are shares that only trade a few hundred to a few thousand shares daily. These stocks are “thin” or “inactive traders” compared to stocks that trade hundreds of thousands, if not several million shares trading daily. These include Canadian banks, or major utilities, for example. With fewer transactions taking place in their shares, thin traders are often more volatile than actively traded stocks, especially in reaction to unforeseen news.
If shares have low trading volume, you may want to put a limit on the price you are willing to pay if you are buying, or the price you are willing to accept if you are selling. In that case, you would set your limit on buy orders above the price of recent trades. It’s better to pay a little more or receive a little less than to miss out entirely on your best ideas.
Bonus tip: Watch out for frequent trading
Since stock trading—including market and limit orders—is accessible to nearly every investor with a discount brokerage account, it’s far too easy for investors to buy and sell stocks. But remember, for every trade you make, buy or sell, you incur a fee. Depending on your brokerage account this will incur commissions. These fees only eat into profits and make it harder for you to realize long-term gains.
Whatever type of order you use, watch that you don’t sell to soon
Selling too soon is one mistake that many investors make. They may sell off good investments in anticipation of a market downturn. Or in times of market pessimism, investors may be tempted to sell all of their stocks, regardless of quality, in hopes of getting back in at lower prices.
Selling to sidestep a market downturn rarely works out as neatly or as profitably as sellers hope. First, some stocks hold steady or rise during a downturn—these are often the strongest stocks in the subsequent upturn. And sometimes the downturn ends much more quickly than you expected, and you wind up buying back in months or even years later, at much higher prices.
Other times, the market moves up, the seller buys back in, and the real downturn begins.
At TSI Network, we encourage investors to find and hold (or buy and watch carefully) shares in well-established companies, especially ones that pay dividends. Market downturns will always occur from time to time but over the long term, keeping your purchases—including those made with either market and limit orders—to a minimum will greatly increase your profits.
Do you use market or limit orders when you buy and sell stocks? Has your choice led to any particularly good or bad results? Share your experience in the comments section.
Note: This article was originally published in 2012 and has been updated.
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