Market Orders vs Limit Orders in Practice

Choosing the right order type can save you money and improve execution. This lesson explores practical applications beyond the basics. [DEFINITION] Order Type: Instructions to your broker specifying how to execute a trade, including price conditions, timing, and fill requirements. ### Market Orders in Practice **When to use market orders:** - Highly liquid stocks (millions of shares daily volume) - Urgent situations requiring immediate execution - Price is less important than certainty of execution - Small positions relative to trading volume [EXAMPLE] You want to buy 100 shares of Apple (AAPL), which trades 50+ million shares daily with a $0.01 spread. A market order will fill instantly at essentially the displayed price. **When to avoid market orders:** - Low-volume stocks (spread can be wide) - Before/after market hours (limited liquidity) - During extreme volatility - Large orders relative to volume [WARNING] In volatile markets or illiquid stocks, market orders can fill at prices far from what you expected. This is called "slippage." ### Limit Orders in Practice **When to use limit orders:** - You have a specific price target - Stock has wide bid-ask spread - Trading smaller or less liquid stocks - Setting entries/exits in advance [TIP] Even if you want to buy immediately, using a limit order slightly above the current price protects you from slippage while almost guaranteeing execution. ### Advanced Order Types **Stop-Limit Order:** Triggers a limit order when stop price is reached. - Stop at $48, limit at $47 - If stock hits $48, order activates as limit order at $47 - Risk: May not fill if price gaps through your limit **Trailing Stop:** Stop price follows the stock price by a set amount or percentage. - Buy at $50, trailing stop at $5 - If stock rises to $60, stop is now $55 - Locks in gains while allowing upside **Fill-or-Kill (FOK):** Order must fill entirely immediately or cancel completely. **Immediate-or-Cancel (IOC):** Fill what you can immediately, cancel the rest. **Good-til-Cancelled (GTC):** Order remains active until filled or cancelled (usually up to 90 days). ### The Bid-Ask Spread [KEY] The spread is a hidden cost. Buying at ask and selling at bid means losing the spread immediately. [FORMULA] Spread Cost = (Ask - Bid) × Shares [EXAMPLE] Stock has $49.95 bid, $50.05 ask (10-cent spread). You buy 1,000 shares at $50.05 and sell at $49.95 immediately. Loss: $100 just from the spread. ### Order Routing Considerations Your broker routes orders to exchanges or market makers: - **Price improvement:** Some routes offer better than displayed prices - **Payment for order flow:** Broker may route for their benefit - **Direct access:** Active traders may want to choose routes ### Practical Scenarios [EXERCISE] You want to buy a small-cap stock trading at $15 with a $14.90 bid and $15.10 ask (1.3% spread). What order type should you use and why? |ANSWER| Use a limit order at $15.00 or slightly below. With a wide 20-cent spread, a market order would cost you $15.10 (the ask). A limit at $15.00 might get filled between the spread, saving you $0.10 per share. For 500 shares, that's $50 saved. [SCENARIO] You own a stock at $100 and want to protect gains but let it run. The stock is volatile. What order strategy might work? Consider a trailing stop. For example, set a trailing stop at 8%. If the stock rises to $120, your stop trails to $110.40. If it then falls 8%, you sell at approximately $110.40, locking in gains. You don't cap upside but protect against major declines.