Executing trades efficiently is a core part of helping clients manage their portfolios. Every trade starts with a decision about how to place the order and the type of order one chooses. Among the different order types available, the market order is preferred for its speed and simplicity.
Market orders are often the first order type that new investors encounter, but even seasoned financial advisors need to know when and how to use them. In this article, Wealth Professional Canada will discuss what a market order is and how it compares to limit orders.
A market order is the simplest type of order you can place when buying or selling a security. With this order, investors are asking to buy or sell at the best available price in the market at the time the order is sent to the exchange.
When a market order is placed to buy a stock, clients will pay the market’s ask price. If a market order is placed to sell, clients will receive the market’s bid price.
Market orders are usually executed almost instantly during normal trading hours, especially for securities that are highly liquid and have a large trading volume. This makes market orders a popular choice for trading these:
Watch this video to learn more about this order type:
Market orders can be used to buy or sell different types of derivatives. They also help make sure that trades are executed quickly at the best available price in fast-moving derivatives markets.
The price that clients pay or receive with a market order might not always match the last quoted price seen before placing the order. This is especially true for highly traded securities, where prices can change rapidly.
If clients are buying or selling a large number of shares, or if the security is not very liquid, the trade might be filled at more than one price. This happens because the order is matched with the best available prices in the market at the time.
Also, there might not be enough shares available at a single price to fill the entire order.
Market orders are best suited for situations where getting the trade done quickly is more important than getting a specific price. They are also the only option if clients want to buy or sell fractional shares. On the contrary, limit orders can only be used for whole shares.
If a market order is placed outside of regular trading hours, the order will be queued and sent to the exchange when the market opens. Any unfilled market orders for stocks will expire at market close and will be cancelled.
Market orders are straightforward to place. On most trading platforms, it is as simple as these three steps:
The broker or trading service will then execute the order at the best available price.
In fast-moving markets, especially when selling, the execution price can be significantly lower than expected. This is why understanding the liquidity of the security and current market conditions before placing a market order is a must.
If there are other pending orders ahead of a client’s order, it might take longer to process, depending on the volume and liquidity of the security.
Market orders are best used for securities with high trading volumes and tight bid-ask spreads. For thinly traded stocks with low volumes and wide bid-ask spreads, market orders might result in higher trading costs and unexpected execution prices.
It depends on the specific needs and goals of the investors as well as the characteristics of the security being traded.
A market order is best when clients want to buy or sell a security immediately and are willing to accept the current market price. This is ideal for highly liquid securities, where trades are executed quickly and the difference between the bid and ask price is generally small. Some examples include large-cap stocks and ETFs.
The main advantage of a market order is speed. Trades are filled as soon as possible, which can be critical if there is a need to enter or exit a position quickly.
A limit order gives clients more control over the price at which they buy or sell. With a limit order, clients can specify the maximum price they are willing to pay when buying. They can also do this with the minimum price they are willing to accept when selling.
The order will only be executed if the market reaches the specified price within the time frame set for the order. This can help clients avoid paying more than they want when buying or selling for less than they want when selling.
Limit orders are especially useful for securities with lower trading volumes, wider bid-ask spreads, or when clients are not in a rush to complete the trade. However, there is no guarantee that a limit order will be filled. If the market does not reach the specified price within the duration of the order, it will expire unfilled.
Limit orders are mostly used for whole shares, not fractional shares. If clients want to trade fractional shares, they must use a market order.
When deciding between a market order and a limit order, here are some considerations:
Overall, the best choice depends on the priorities of the investors and the market conditions at the time of the trade. Watch this video for more:
This guide on how to invest in stocks in Canada introduces these order types as part of the basics.
To help explain market orders, here is a sample scenario:
Suppose Client X is interested in buying shares of Company A. The current bid price for the stock is $10, and the ask price is $15. There are 100 shares available at the ask price of $15.
If a market order is placed to buy 300 shares, the first 100 shares will be filled at $15 each, as that is the best available ask price.
Because there are only 100 shares available at $15, the next 200 shares will be filled at the next best available prices in the market. If the stock is thinly traded and the next best ask price is $18, those 200 shares might be filled at $18 or higher. This can result in Client X paying more than expected for the entire order.
This example highlights one of the main risks of market orders, especially for thinly traded securities. When there is not enough liquidity at the current ask price, large market orders can be filled at multiple prices.
Some of these might be significantly higher (for buys) or lower (for sells) than the price seen before placing the order. Watch this video for more examples not just for market orders but for other order types:
Using market orders might be beneficial when buying blue-chip stocks, since these securities generally have tight bid-ask spreads. They also have enough trading volume to fill orders quickly.
Remember that in fast-moving markets, the price can change quickly between the time an order is placed and when it is executed. This can lead to investors paying more or receiving less than expected.
If clients want to avoid this risk, especially when trading thinly traded stocks or large order sizes, financial advisors might suggest using a limit order instead. With a limit order, clients can set the maximum price they are willing to pay. Plus, the order will only be filled at that price or better.
It’s always worth taking a moment to think about the details before placing a trade. While market orders are fast and easy, they’re certainly not the right choice for every situation. The best results come from matching the order type to the needs of the trade.
When speed matters and the security is actively traded, a market order can be the best path forward. In other cases, a limit order might be better. Either way, consider the price sensitivity and urgency of the trade before choosing an order type.
Looking at the security’s liquidity can also make a difference in the result. Paying attention to these elements can help avoid unwanted surprises.
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