Market Order or Limit Order

Trading Tip

Some friends asked me what order type they should choose when input an order. Is market order better or limit order better?

Generally speaking, if your target price is little far from the current price, you must set a limit order. If the price change is fast and you don’t want to miss the deal, or the current price is your target price, you need use market order.

Because most of us are using online broker such as E*Trade, AmeriTrade, TDWaterhouse, or Scottrade etc, the story is changed. I suggest using limit order instead of market order.

I checked online brokers rating at different performance measurements. It seems the popular ones are OK at most of cases. From my experience, I think their key problem is the information delay and their execution quality.

All of them claim that they provide “Real Time” information. The problem is how “Real” it is. In another words, how long the information delay is. Delayed information would impact your investment decision especially for more active and volatile stocks. And it would lead you a worse execution quality.

For example: If you got a quote that the price of stock A is $10.00, at that time, the real price of A is at $10.20; when you put a market order, because of the delay, when it executed, its market price is at $10.40 already. You would certainly feel you are fooled when you look at your execution result.

Sometimes the delay is reasonable and unavoidable. It caused by processing delay, the network etc. Sometimes it is not reasonable. It caused by bad system design and implementation, or purposely “bad” algorithm.

Most of the online brokers have limited trade volume. They would always try to match their clients’ orders within their book first. Only when there is no any possible match available, then they will pass the order to ECNs, or exchanges, or other brokers. In the second case, they have to pay commission to the third party, which is against their own benefit.

I guess an unmatched order will technically stay in an online broker’s book for a short of period, just to wait for another possible incoming match. It would be another source for the “delay”.

When a user input a market order, if there is a possible match, at most case it would be a limit order, resist in their book, the online brokers will execute them as much as possible. When a limit order matching a market order, the market order side is the loser most likely. The reason is simple, if the limit order is at the “real” market order price, it should be get executed and removed from the book.

I have had several unpleasant experiences with market order through my online broker. So I decide to avoid using it. If I really want to make the deal, I would set a limited order and give a small room for the price. I can afford to pay pennies more for a stock, but I don’t want to see a shock result.

My suggestion is to avoid market order when you are using an online broker.