Who: This post is for people who often use market orders when purchasing their stocks. This post will be helpful for people who are looking to optimize their trading strategies for maximal gains (who isn’t?)
What: This post will discuss the merits of using limit orders to buy and sell stocks as opposed to market orders.

Market Order vs. Limit Order: What’s the Difference?

Simply put, a market order just allows you to specfy the symbol and the number of shares you want to buy or sell. Your purchase will be routed to the appropriate parties who will get you the shares at the then current market price.

On the other hand, a limit order requires you to specify a specific price or limit on the maximum you want to buy a stock for or a minimum you want to sell a stock for. Your trade is then routed to the appropriate parties and filled only if the price is >= to your limit (for a sell) or the price is <= your limit (for a buy.) Finally, with a limit order you can pick a time period for your order to be active. You can set it to expire at the end of the day, if your order has not been filled, etc.

Why Use Limit Orders?

First of all, using limit orders is especially critical when you are trading stocks of small companies. As explained in my post about Penny Stocks, small companies have illiquid stock prices. This means that they do not have a high volume and for the most part the difference between the price the stock is selling at and the price that people are offering for the stock (bid/ask spread) is somewhat high. It is very important to use limit orders when making purchases or sales of these stocks because market orders may vary wildly in price from the last reported price of the security. The price movements in illiquid stocks are usually larger in that they come in “chunks,” so it is in your best interest to control your orders/sales.

Second, limit orders give you a level of control over your purchases and sales. By setting a buy price just below the current price of the security, you can save a few cents per share and automatically have the purchase be made on a slight downtick in the stock. If your buy price is RIGHT below the current price, a slight market movement downward will allow you to get your stocks at a slight discount.

Let’s assume you are buying 100 shares. If you place a limit order to buy at $50 in the morning when the stock is at $53 and the stock dips to $50 in the afternoon and and then hits $52 right before close… You’re in pretty good shape. If you had put in a market order at $53, you’d be down $100. However, since you placed a limit order at $50, you are $200 in the money.

The downside to this is that you may miss out on potentially large price jumps if the stock price never hits your limit. For example, if you set your buy price at $50.01 and the current stock price is $50.02 and it shoots up to $55.00 without ever going to $50.01, you’ll never have made the purchase. If you were going to purchase 100 shares, you’d have missed out on a $498 gain by trying to save $1. Is it worth it?

If you think that this second point sounds a lot like trying to time the market, you’re not crazy. However, while I do not advocate trying to time the market, there are instances in which you are willing to pay a certain price for a given security at a given time, and no more. For these cases, it is best to place a limit order at a price you are comfortable with. If your limit is never reached, the trade is never made. If the limit is reached, you get a purchase that was made at a price *you* agreed to, not Mr. Market.

Be Careful!

Though it is getting rarer, some brokers charge more for limit orders and other special types of orders than they do for regular market orders. When you are choosing your broker, make sure to look for one that does not charge extra for limit orders.

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