The two most popular and easiest ways to buy/sell a stock or ETF through an online broker is with a market order or limit order.
For every trade to happen, there needs to be a buyer and a seller at an agreed upon price. It’s the basic premise of how the stock market works. Of course, how that happens will depend on the different order types you use.
For the average investor out there, when it comes down to market order vs. limit order, one offers more advantages than the other.
Supply and Demand
Each stock trades differently based on the number of shares available (supply) and the demand for those shares. Big blue chip stocks tend to have a large amount of available shares, high daily trading volumes, and lower price fluctuations between trades.
When you get into the small cap or more obscure stocks, there tends to be a lower number of shares available and/or lower daily trading volumes, which can lead to higher price fluctuations.
This is true with ETFs too, where the difference in trading volume can range from billions of shares traded in one day for one ETF, to just a few thousand for another ETF. This is the main reason we recommend sticking with the more popular (higher daily volume) ETFs.
So why does all this matter? When you eventually buy or sell a stock or ETF, trading volume (supply) and demand will play a role in the price. More importantly, a lack of supply or high buyer demand will quickly push the price higher. Or an increase in supply or high seller demand will quickly push the price lower.
All of this may affect the price you buy/sell at, depending on the type of order you use.
Market Order Defined
A market order is an order to buy or sell a stock at the best available price. Generally, this type of order will be executed immediately. However, the price at which a market order will be executed is not guaranteed. It is important for investors to remember that the last-traded price is not necessarily the price at which a market order will be executed. In fast-moving markets, the price at which a market order will execute often deviates from the last-traded price or “real time” quote. – SEC
Basically, a market order happens immediately, or almost immediately, at the market price. You are stuck with any swings in the stock price from the moment you hit the buy/sell button to when the order goes through. On the buy side, this could lead to paying more than expected. On the sell side, it could lead to selling for less than expected. Of course, the opposites are also true, because with a market order you just never know.
A market order offers no protection from price spikes. A regular occurrence on high volatility days where 1-3% moves are normal. Over time that difference adds up. Remember the flash crash? Proctor & Gamble, a blue chip stock, almost hit the floor only to return to its normal trading range. Anyone caught with a sell market order in those few seconds lost their shirts.
Even though, price spikes and flash crashes don’t happen often, a market order offers no protection from these big price swings.
Limit Order Defined
A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute. A limit order can only be filled if the stock’s market price reaches the limit price. While limit orders do not guarantee execution, they help ensure that an investor does not pay more than a pre-determined price for a stock. – SEC
My preferred order – limit orders let you set the price you want. This eliminates the guessing game of a market order. But it doesn’t guarantee that the order will go through. If the stock never reaches your order price, nothing happens.
This may seem like a bad thing. You could miss out on a sale or miss out on a great buying opportunity. In my experience investing is about discipline. Setting the price feeds right into that. I’d rather miss out on an order going through than being at the whim of the markets entirely.
If you are really afraid of losing out on a buying opportunity, just set your limit order slightly higher than the market price. When you want to sell immediately, just set your limit order slightly lower than the market price. This gives you the protection from price swings without having to worry about whether your order goes through or not.
Which Is Better?
I say stick with limit orders. The reality, for the average investor, is that limit orders offer more safety, discipline, and control over your investments.