market order vs. limit order

The two basic types of stock transaction orders are market and limit.

A market order tells your broker to execute the transaction immediately at the best available price.  Your mindset should be that being sure the trade is done is more important than the price it is accomplished at.  You might, for example, be using the proceeds from a sale to pay a bill or to buy another stock the same day.

For highly liquid stocks, an individual’s market order should have little or no impact on trading.  So a market order should get you a price at or near the quote you see on your computer screen.  Microsoft, for instance, trades over 60,000 shares a minute.  So a 100-share, or even a 1,000-share order, is just a drop in the bucket.

In my experience, the only time a market order might be a worry is in the case of an illiquid stock where your order would be a significant portion of the day’s trading volume.  If so, a market order could get ugly.  When I ran a small institutional trading operation for a number of years, I thought that I could be no more than a quarter of daily trading volume.  Big institutions figure they can be no more than 10% without making a visible impact on prices.

A limit order specifies a price that is the maximum you will pay to purchase or the minimum you will accept for a sale.  The broker is required to transact at the limit price if the opportunity presents itself.  He is permitted to transact for you at a more favorable price than the limit, but is not allowed to transact at a less favorable one.  So the trade may not get done on a given day.  Depending on your instructions, your unfilled order will either be cancelled at the end of the day or carried over to the next trading day.

Typically a limit is set at a better price than the current market.  I may enter a limit order, for example, to buy a stock at $68 when it’s trading at $70.

But a limit can also be set at a worse price for me than the current market and used as a quasi-market order.   If I want to buy a less-liquid stock, for example, I can enter a limit order at $70.50 when it’s now trading at $70.

Personally, I use limit orders a lot.  When I’m buying I will typically buy a third of my intended position at the market and set a limit at, say, 5% below the market for the second third.  If the stock hits that limit, I’ll set a lower limit for the final third.

I’ll scale up in a similar fashion when I’m selling.

Stops tomorrow.