Understanding Market Orders vs Limit Orders

Consumers today are spoiled for choice, whether it is buying goods or services or selecting stocks to invest in. With numerous options available, executing a trade involves various order execution choices provided by brokers. At times, the distinctions between these order types can become blurred, making order execution a challenging task.?

In this article, let’s explore the various options available to investors for order execution, with a particular emphasis on market orders and limit orders.

What is a Market Order?

Simply put, a market order, when placed in your Demat account or through a broker, involves buying a particular stock, bond, or any other tradeable asset at the best available price. Most of the time, this best available price corresponds to the current market price, visible in real-time.

For instance, if the real-time price of ‘Stock A’ is Rs 542, and you place a market order to buy it, the trade will be executed very close to this price, given the liquidity of the asset. Market orders are the default choice provided by brokers to investors, especially when they are in a hurry to buy a specific stock, expressing their willingness to pay the current market price.

What is a Limit Order?

In contrast, a limit order involves the investor specifying a particular price at which the asset should be bought or sold. This specified price, known as the ‘limit price,’ differs from the current market price. Importantly, the trade may or may not be executed, depending on the convergence of the current market price and the limit price set by the investor. Limit orders are generally preferable for buying volatile or thinly traded assets.

For example, considering the same ‘Stock A’ with a current market price of Rs 542, if you place a limit order to buy at a limit price of Rs 535, two scenarios could unfold. If the stock’s price hits a low of Rs 537 during intraday and then reverses to a new high of Rs 560, the trade won’t be executed and will lapse. On the other hand, if the stock touches Rs 535 during the day, the limit order would be executed immediately.

Which one is better?

Both market orders and limit orders have their pros and cons, and their usage depends on various factors:

A Market Order can be placed when:

• You want the order to be executed quickly.
• You are trading in a liquid asset with narrow bid-ask spreads.
• The trade quantity is not extremely high.

Market orders are suitable when urgency is paramount and the asset is easily tradeable, ensuring the trade is executed close to the current market price.

A Market Order can be avoided when:

• A trade is being executed in a less liquid asset.
• During highly volatile market conditions.

Market orders are less reliable in less liquid instruments or during high market volatility, where wider bid-ask spreads could result in execution at undesirable prices. In such cases, a limit order is a better choice.

A Limit Order can be placed when:

• You want to buy an asset at a specified price.
• You are dealing with an asset with a high bid-ask spread and low liquidity.
• You are trading a high number of shares.

Limit orders are suitable when you have a predetermined price level in mind and are advantageous for assets with high bid-ask spreads, preventing undesired price fills.

A Limit Order can be avoided when:

• You are not comfortable with the order going unexecuted.
• You are unwilling to make partial trades.

Limit orders may miss opportunities or result in partial executions, making market orders more suitable in these situations.

Other Types of Orders

In addition to market and limit orders, prominent brokers in India offer various order execution types, including Stop Loss Orders, Good Till Triggered Orders, and After Market Orders (AMO), each serving specific purposes.

Conclusion

To avoid confusion, investors can focus on market orders and limit orders, understanding their pros and cons. These orders should be chosen based on the urgency of the trade and the liquidity of the asset. Exploring other order types through practical implementation with small-value trades can help investors understand their features and use them effectively in the future.

*The article is for information purposes only. This is not an investment advice.

*Disclaimer:?Teji Mandi Disclaimer

Note:?This article was originally written by Teji Mandi for ET Markets.

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