Investors who invest or trade in the stock market place an order to buy or sell a stock. Market order and limit order are two most common types of order in the stock market where one needs to place in order to execute a trade. Buying or selling stock in the stock market is not much different from buying or selling a motorcycle or car.
For instance, when you plan to buy a car either you pay the fixed price to the dealer and get the car or you negotiate and refuse to finalize at the fixed price unless the dealer meets your set price. Buying stock is the same thing.
A market order is an order which places at whatever price a stock going on however a limit order is the type of order where you set a price and if the stock hits that price, the trade executed at your set price.
To better understand this, let’s take an example.
Let’s suppose if you are planning to buy a ‘Call’ Option of Nifty50 of strike price 11800 which is at a premium of Rs. 17.50. As per your analysis, the market is already down and to you, it is a good opportunity to buy that ‘Call’ Option. In that case, you would like to enter the trade by placing a quick order to buy that ‘Call’ Option at the best price. In that situation, a market order will execute at whatever the buyer is bidding.
So, if Rs. 17.50/share is the best price then in using a market order, a trader can place an order to buy a lot of 75 shares of Nifty ‘Call’ Option of strike price 11800 and enters the trade.
Market orders are placed as per the guidelines. The biggest advantage of using a market order to enter a trade is that your broker can execute quickly and a market order will execute at whatever the price the seller is asking.
But, with the advantage, there is a drawback –
If the price moves quickly, one can end up trading at an entirely different price. Furthermore, there is also a possibility of high fluctuations between the time a broker receives the order and the trade is executed.
Use market order when –
- You are looking to quickly execute a trade at available cost,
- You’re trading a stock with high-liquidity stock with a narrow bid-ask spread,
- You’re trading only a few shares etc.
Now let’s come to the point where you don’t wanna enter the trade in current premium and wanna negotiate.
Limit orders allow controlling the stock over buying and selling prices. With the limit order, a trader can set a specific price prior to placing the order.
Let’s take the same example:
Assume the same ‘Call’ Option of Nifty50 of strike price 11800 which is at a premium of Rs. 17.50. As per your analysis, the market is overbought and the same call will soon come to Rs. 13.00. In that case, instead of buying in the market price you can set a price of Rs. 13.00 by placing a limit order where the trade will only execute when the Option Call will come down to your set price.
When the price come down to Rs. 13/share, the trade will automatically execute. But, if the stock never reaches the limit price then the order will not execute.
A limit order ensures the entry and exit points of trade are as per your specified price.
Use limit order when –
- Your analysis tells you that the price will change.
- You are going to trade illiquid stock and bid-ask spread is large.
- You’re trading a large no. of shares.
Both orders have their own advantages and disadvantages. All you need to do is to analyze your existing circumstances, the stock you are planning to trade, or your strategy to make going forward.
If you have any query or would like to add something then doesn’t forget to mention in the comment section below.