Order types

Order types are different types of trading orders that investors can use when buying or selling shares or exchange-traded funds (ETFs) on a stock exchange, through a brokerage account. The two main types are market orders and limit orders.

A simplified view of the market
The market contains all traders willing to buy or sell the security. If traders are willing to buy and sell at the same price, then a trade will be made. If you want to buy or sell, you add your own order to the market, and it will either be executed immediately or added to the available orders in the market.

Your broker will give you information about the market; you might see a display like this:

The size is in hundreds of shares, so this display says that traders have offered to buy 500 shares of XYZ at $19.98, and to sell 1000 shares at $20.02. The bid-ask spread is four cents.

Market order
A market order is used to buy or sell a security immediately, at the best current price. On highly liquid stocks or ETFs, market orders are filled nearly instantly.

Using this type of order, sellers obtain the current bid price and buyers pay the current ask price, as determined by the market.

The advantage of a market order is that you are almost always guaranteed your order will be executed (as long as there are willing buyers and sellers).

The disadvantage is that the price you pay when your order is executed may not always be the price you obtained from a real-time quote service or were quoted by your broker. This may be especially true in fast-moving markets where prices are more volatile. When you place an order "at the market," particularly for a large number of shares, there is a greater chance you will receive different prices for parts of the order.

Market order example
Refer to the example security shown above. If you place a market order to buy 1000 shares, you will buy them for $20.02 a share if the sell order is still there; your total price is $20,020.

However, the sell order might have been taken by another buyer, or withdrawn by the trader, before your broker processed your order. In that case, you will still buy the shares, but at the next-best price or prices.

If there were 500 shares for sale at $20.04 and 2500 at $20.05, you would buy all the shares at $20.04 and 500 at $20.05, a total price of $20,045.

Limit order
A limit order is used to buy or sell a security at a specified price. The order will only be filled at the limit price, or better. Otherwise, it will not be executed.

In other words, 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.

Reaching the desired price does not automatically guarantee a sale, as every transaction must have both a buyer and seller. When the security hits that price, you get in line with the rest of the people at that price and wait for execution. If there is low volume, you may not get an execution.

A common compromise between the two types of orders is a marketable limit order. This is considered the least risky way to buy shares or ETFs, particularly those with low trading volumes. A marketable limit order is an order to buy at the current ask (or a cent or two above), or sell at the current bid (or a cent or two below). If the ask or bid is still there when your order is placed, it will execute immediately because there are now matched orders to buy and sell at the same price. But if the ask or bid has changed, your marketable limit order remains a limit order at the same price, instead of immediately executing at another price.

Limit order example 1
Refer to the example security shown above. If you place a limit order to buy 1000 shares at $20.00, you may not buy them at all, but your order will become the new bid.

If someone else places a market order to sell, or a limit order to sell at $20.00, then you will buy the shares and pay $20,000. But if nobody accepts your order, you might find that XYZ has gone up to $21 and you still do not have the shares.

If you place a marketable limit order to buy 1000 shares at $20.02, you will buy the shares for that price if the sell order is still there, just as if you had placed a market order.

But if the sell order is gone, you do not buy at a higher price; rather, your order is added to the market, and may be accepted by another trader at $20.02. You will not buy at a higher price unless you modify your order.

Limit order example 2
Marketable limit orders reduce the risk if the offer at the ask is withdrawn and the next-lowest offer might be significantly higher.

Refer again to the example security shown above. A trader who was willing to sell at $20.02 withdraws his offer (or has someone else take it first), and places a new offer to sell at $20.03.

In the one second interval between the withdrawal of $20.02 and placement of $20.03, a next-best offer appears from someone else at $21.

If you place a limit order to buy 1000 shares at $20.02 during that one second, it will not execute, thereby protecting you from a purchase at the much higher price of $21. The new ask of $20.03 appears next and you can modify your limit order to accept $20.03.

Compare this to a market order to buy 1000 shares. The $21 offer would have been accepted, resulting in a cost of $21,000 rather than $20,030 (a difference of $970).