So now that you know a little bit about how the stock market works, let’s make sure you have some of the lingo down. As you will see below, ignorance on some of these terms can make your slick trading techniques costly. Today we are going to discuss market orders versus limit orders.
The most common type of order used when buying or selling both common and preferred stock is called a market order. There are times when you might want to use a limit order, accompanied by one or more qualifications, however.
When you place a market order, you are telling your broker to execute the order at whatever the available price happens to be. For example, let’s suppose you see that the common stock of Oracle (ORCL) is currently selling for $33.68 and decide you want to purchase 100 shares. Assuming you have already established an account with a broker, you can simply call or go online and indicate you want to buy 100 shares of ORCL. In this case, you might end up purchasing the shares for the $33.68 you observed or for a price that is pennies higher or lower.
Similarly, if you were the owner of 100 shares of ORCL and placed a market order to sell the stock when you saw a price of $33.68, you might receive $33.68 for your 100 shares, or a price that is slightly higher or lower.
The advantage associated with this type of order is that the order will be executed. That is, you will end up buying or selling the shares. The disadvantage is that you won’t know at exactly what price your order will be executed.
If you want to be certain that you will be paying no more than a certain amount for a stock or selling your stock for no less than a certain amount, you can enter a limit order to buy or sell it. For example, let’s suppose that you decide Oracle would be a good investment. You observe that ORCL’s current price is $33.68, which you think is a fair price, but you don’t want to pay any more than this. If you enter a limit order to buy 100 shares at $33.68, your order will be executed only if the shares can be purchased for $33.68 or less. If ORCL’s price has risen to $33.69 by the time your order hits the market and continues to rise, your order will fail to be executed.
Alternatively, maybe you believe ORCL’s current price of $33.68 is fair, but you think the entire stock market is going to take a dip over the next couple of days because of some of the recent economic news, and you think ORCL might drop to $33.60. You could enter a limit order to buy the shares at $33.60, which ensures that you will pay no more than this. But, again, if ORCL doesn’t drop to $33.60 while your order is open, the purchase will not be made.
As another example, let’s assume you own 400 shares of Dillard’s, Inc. (DDS) that you purchased a while back for $50 a share, and you see that DDS is now selling for $81 a share. You believe that the price has probably peaked, but decide to sell only 300 of your shares, just in case you’re wrong. You could, of course, enter a market order to sell your 300 shares, but if you enter a limit order to sell 300 shares at $81, you are guaranteed to receive a price of $81 or higher for them—unless DDS shares have dropped to $80.99 or less by the time your order reaches the market and continue their downward trend, in which case you will still be the proud owner of all 400 shares of DDS. It’s also possible that when your order reaches the market, there is a bid to buy 100 shares at $81, but all the other bids are lower than this. In this case, you could end up selling 100 shares at $81 and keeping the other 200 shares.
So, while limit orders give you the advantage of specifying the highest price at which you want to buy a stock or the lowest price for which you want to sell it, you also face the risk that your order will be only partially filled or will not be filled at all.
Limit orders enter a queue. Market orders are filled first, followed by limit orders, based on their time of arrival, so even if you enter a limit order to buy or sell at the price that is currently being asked (if you’re looking to buy) or bid (if you want to sell), that price may no longer be available when your order reaches the top.
Day orders vs. GTC orders
How long does your order remain in the queue? This depends on you. If you enter it as a day order, it will remain on the books for the remainder of that same day’s regular trading system. This means if your price is hit at any point prior to the end of the trading day and there are a sufficient number of shares at that price (or better) to fill your order, your order will be executed, and you will receive confirmation of this from your broker. Otherwise, your order will be cancelled unfilled.
Alternatively, you can leave it on the books for a longer period of time by specifying Good-til-cancelled, or GTC. How long “good-til-cancelled” is varies among brokers. Discount broker Charles Schwab leaves GTC orders on the books for 60 calendar days unless the investor cancels the order.
GTC orders can result in higher commissions that can eat up your profits if your order ends up getting executed in pieces over a number of days. For example, let’s suppose you specify “GTC” on your limit order to sell 300 shares of DDS at $81, and only 100 shares sell that first day for $81. But maybe two days later, DDS stock starts to climb again, and another 150 shares are sold for $81.12, but the last 50 shares don’t get sold until the next day, at a price of $81.03.
Because the sales took place on 3 separate days, you will be charged 3 commissions. This isn’t an issue with a day order because the order is executed in whole or in part within the same day, and any portion that isn’t filled is cancelled at the end of the day’s trading session. Even if it requires multiple trades to fill the entire order and the trades occur hours apart, only one commission is charged if the trades take place within the same trading session.
To further illustrate, let’s assume your broker charges a flat commission of $10 for the typical order to buy or sell a stock. If your limit order is a day order and only 100 shares are sold within that day’s trading session, you will pay a $10 commission to sell your 100 shares. If your limit order is a day order and all 300 shares are sold within that trading session, you will pay a $10 commission to sell all 300 of your shares. If, however, you place a GTC order, and the order is filled in 3 different trading sessions, it will cost you $30 to sell your 300 shares.
“Fill or Kill” and “All or Nothing”
You can avoid this last scenario by specifying “Fill or Kill,” or “All or Nothing” when you place your limit order. “Fill or Kill” instructs your broker to execute the entire order immediately or cancel it. So, if your limit order to sell 300 shares of DDS at $81 cannot be filled in its entirety after it is entered, it will be cancelled. “All or Nothing” indicates that you do not want partial orders to be executed; you want all 300 shares sold at the same time or none at all. This differs from a Fill or Kill order in that the order need not be cancelled if it cannot be executed immediately. It can remain on the books, but can only be executed in its totality if and when that is possible while the order remains open.
If you have any questions or comments on this post, let me know. Otherwise, I will see you tomorrow for another day at basic finance bootcamp! Don’t forget to sign up for the newsletter!