Smart investors won’t ignore market order vs. limit order differences

When stock market trading, most investors place “market orders” or “limit orders.”  However, which is the better form of order? It’s a decision many investors have to make each time they buy a stock.

When you understand the use of market and limit orders, you can improve the profitability of your stock investments.

Market order vs. limit order: What’s the difference?

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 between the time you place the order and the time it is filled.

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.

This can create an unfortunate dilemma: an unfilled order is much more likely to occur with your best choices, since they are far more likely to shoot up faster than you anticipated. But you’ll always get your worst choices filled. In fact, they’ll come down to meet your price, then go lower.

For most investors, market orders are a better approach than limit 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. In contrast to limit orders, market orders are almost always filled within a very short period of time—in minutes, if not seconds.

However, you only learn the price you paid (for a purchase) or received (for a sale) after the order is filled. The market price may change, for or against you, between the time you place the order and when it is filled.

In general, 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.

Limit orders may be useful for thin-trading shares

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 see hundreds of thousands of their shares, if not several million of their shares, trade each day. 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.

With thin trading shares, 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). 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 investing 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, whether it’s a purchase or a sell, you incur a fee. Depending on your brokerage account, you may also incur commissions. Altogether, these costs eat into your profits and make it harder to realize long-term gains.

Some investors will use limit orders if they are focusing on producing income through dividend stocks. Do you think this is a good strategy for maximizing the rate of return or do think there are easier ways. If so, what do you see as an easier strategy to use?

Limit orders seem like a good idea on the surface, but they can lead investo losses. Do you agree or disagree? How have limit orders worked in your favour?