What Is a Market Order?

A market order is the most basic trade order when buying or selling a stock. It instructs the broker to buy or sell “at the market,” or the best price available. Market orders are almost always filled immediately since there is no price specified. However, no price is guaranteed.

Trade orders are executed automatically by systems of computers with established queue procedures. Orders are taken on a first-come, first-served basis, with the most basic orders executed the quickest. Because market orders come with no restrictions on share quantity, share price or trade timing, they cut to the front of the order queue. Any type of order restriction complicates a trade, requiring more effort to execute.

Pending orders are arranged by price. The highest ask (sell) price is placed at the top; the lowest bid (buy) price is placed at the bottom. These are the “best” prices offered for buying or selling a specified quantity of stock during market trading hours. This is the essence of buy low, sell high.

For example, Renewable Energy Group Inc. (REGI) is currently quoted at a bid of $61.00 and at an ask of $61.43. With a market order to buy, the investor would receive shares that are selling at $61.43; with a market order to sell, the investor would relinquish shares that are being bought at $61.00.

Your broker should display the number of shares being offered at given ask or bid price and the exchange where the trade is offered, in addition to the general volume of shares being traded. This information will change in real time.

Presuming the hypothetical investor’s entire order was filled by the quantity of shares offered at the bid and ask prices, the market order is executed and filled at those prevailing prices.

However, it is possible for the bid and ask pricing to change between the time you enter your market order and the time your broker executes the trade. You will receive the current price at execution.

Are Market Orders Bad?

Investors should be wary of when and how they use market orders since these orders are made without a price guarantee. For the most part, investors want to control their entry and exit prices into share ownership; market orders do not allow you to do this.

While the trading system arranges the queue to sell high and buy low, in executing a market order this investment mantra is inverted. In the example above with Renewable Energy Group, the market order would buy shares of the stock high and sell low. This might be acceptable depending on the current bid-ask spread.

In general, investors don’t want to trade when the bid-ask spread—the difference between the price of an immediate sale and an immediate purchase—indicates an imbalance or illiquid market for a security. An imbalance or illiquid stock puts trading power on one side of the seller-buyer dichotomy.

When a bid-ask spread changes between the time you place a market order and the time the order is executed, the difference in the spread is referred to as slippage. Slippage applies to each share the market order attempts to buy or sell, not just the total quantity to be filled.

A market maker takes advantage of slippage as a premium for the service they provide other investors. Market makers are large investors or companies holding a quantity of shares of a stock such that they provide the liquidity necessary for trading to function between buyers and sellers. During normal trading, market makers are effective for all investors by ensuring a regular balanced volume of shares.

Market makers earn their premium through their position of scale in the market. In agreeing to buy or sell shares at the investor’s quoted price, the market maker will in turn trade the same shares at a slightly better price in either direction. A relatively marginal spread can add up to a sizable profit for a market maker who is trading thousands of shares a day. Individual investors have no way of regularly operating at a scale that allows them to take advantage of bid-ask slippage or share imbalances.

Despite the caveats, market orders are not always undesirable. There are specific situations when a market order is good enough or useful. If the current bid-ask spread is narrow (often one cent) and trading volumes are normal, then slippage is within expectations and can be tolerated.

A market order can be desirable when the market begins to move against you. Remember that market orders are almost always filled immediately due to their efficiency for the broker and the exchange. This makes market orders effective for investors who need to bail quickly on a holding.

Ideally, investors never put themselves in a position where they are financially between a rock and a hard place. But these hard places, or times, do occur as evidenced by any economic depression or recession. Typically, these events are preceded by a bear market where investors lose confidence on a large enough collective level to reverse speculation about the future. A market order in this situation can save you from a much worse outcome.

Market Order vs. Limit Order vs. Stop Order

Investors have to compare the market order to the other two primary order types, limit orders and stop orders.

Limit orders specify a price to be received or paid for a security. This is done by stating the minimum price at which a stock will be sold (if you are selling a security) and the maximum price at which the stock will be bought (if you are a buyer). Limit orders are used to remove slippage costs and exercise more control over a trade.

Limit orders eliminate the risk of slippage by specifying a price. The trade will be executed at the specific price you set or at a better price. One major caveat with limit orders is that they aren’t always filled if the trade price moves away from your specified price. The further away from the bid-ask spread you set your limit price, the less likely it is that your order will be filled. In addition, if the total amount of your order cannot be filled at the specified price, a portion simply goes unordered. For example, if you wanted to buy 100 shares, and only 70 are available at the limit price you set or better, only 70 shares will be filled.

Stop orders make a market order or limit order active once a specified price (the stop price) has been reached. Essentially, stop orders are triggers; once the desired price level is reached, it instructs the broker to execute a market or limit order.

These trades are often referred to as “stop-market” or “stop-limit” orders. A stop-market order tells the broker to seek the best execution, even if the current price has moved away from the trigger price. This is one of the major caveats: There is no guarantee that that the execution price will be equal to or near the activation (stop) price. A buy stop-market order should be placed above the market price, and a sell stop-market order should be placed below the market price.

When you place a stop-limit order, you must specify a stop order price as well as a limit price. A stop-limit order gives the trader precise control over when the order should be filled. The downside is that a stop-limit order will not be filled if the stock’s price moves beyond the boundaries established by the order. A buy stop-limit order price should be placed above the ask price and a sell stop-limit order should be placed below the current bid price.

Closing

A market order is the easiest to enter and execute and guarantees that the order will be executed, but the disadvantage is that you may end up with a less advantageous price than you expected based on the quoted price.

Market orders are best understood in comparison to the other order types that investors can use: limit orders and stop orders. Each order type has specific uses for best practice.