Lesson 3 of 9
Market, limit, stop
Three instructions on the same trade. What each one guarantees, what it refuses to guarantee, and the day of the year on which the difference is expensive.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A market order guarantees a fill and not a price. A limit order guarantees a price and not a fill. There is no order type that guarantees both.
- A stop order is not protection. It becomes a market order once a price is touched, and in a fast fall it sells into the fall.
- The order type matters least in a large, liquid company on an ordinary day, and most in a thin one on the day the news lands.
Three instructions can be attached to the same decision to buy or sell. They differ in one respect: which of two things you are prepared to give up.
What each order type gives up
Market order
- Fills, almost always, and quickly.
- The price is whatever the book offers when it arrives.
- Worst in thin books and fast markets.
Limit order
- Never fills worse than your price.
- May not fill at all, and may fill only in part.
- The risk is missing the trade, not the price.
Every order type trades certainty of execution against certainty of price. Choosing one is choosing which risk you would rather carry.
The market order
A market order says: take whatever is available. In a company trading millions of shares a day, with a penny between the bid and the ask, it fills within a cent of what you saw and the choice was irrelevant.
In a company trading twelve thousand shares a day, the same instruction walks up the book. The fill can be several percent from the last trade, and there is no recourse, because you asked for a fill rather than a price.
The limit order
A limit order names the worst price you will accept. A buy limit at $40.00 fills at $40.00 or better, or does not fill.
The cost is real and it is not money. It is the trade that never happened, where the price moved away and the position was never opened. A limit set a few cents through the market usually fills; one set well away from it is a wish rather than an order.
A limit order can also fill partially, leaving you with 400 shares of the 1,000 you asked for and an order still working for the rest.
The stop order, and why it is misunderstood
A stop order sits dormant until the market trades at or through the stop price. At that point it becomes a market order and takes whatever the book offers.
That is the whole mechanism, and it has a consequence most people do not expect. On a day when a share opens far below the previous close, the stop triggers and the fill happens at the new level, not at the stop price. The stop did not protect anything. It converted a paper loss into a sale at the worst available moment.
A stop-limit order is the variant that adds a floor to the fill price. It solves the previous problem by creating another one: in a fast fall, it may not fill at all, and the position stays.
The arithmetic on the gap day: $36.00 minus $28.40 is $7.60, and $7.60 divided by $36.00 is 21.1 percent below the price the order was meant to defend.
Which one an investor should reach for
The honest answer is that for someone buying a large, heavily traded company twice a year, the order type barely matters and a limit a few cents through the market is a reasonable default.
It starts to matter in exactly three situations: a thinly traded company, an order that is large relative to daily volume, and any moment when news is moving the price. In all three, a limit order turns an unknown cost into a known refusal, which is the trade most long-term holders would take.
Check yourself
What does a limit order guarantee?
- That the order will fill
- That it will not fill at a worse price than the limit
- Both the price and the fill
Show the answer
Answer: B.
Price certainty is bought with execution uncertainty. No order type offers both, and any description that claims otherwise is describing something else.A stop order at $36 triggers on a day the share opens at $28.40. Where does it fill?
- At $36, the stop price
- At whatever the book offers once triggered, which here is around $28.40
- It does not fill, because the price passed the stop
Show the answer
Answer: B.
A stop becomes a market order on trigger. The stop price is the trigger, never the fill, which is why a stop is not a floor under a loss.When does the choice of order type matter most?
- When buying a large, heavily traded company on a quiet day
- When the order is large relative to daily volume, or the book is thin, or news is moving the price
- It matters equally in all conditions
Show the answer
Answer: B.
The cost of a market order is the depth it consumes. In a deep book on a quiet day there is almost nothing to consume, and in the other three cases there is.Sources
- SEC investor education material on market orders, limit orders and stop orders, including the warning that a stop order becomes a market order when triggered.
- Regulation NMS, on the order protection obligations that apply when an order is routed for execution.
What this leaves out
- The comparison table uses invented round prices so the arithmetic can be checked by hand. No real security is described.
- Order types and their names vary by broker. Some offer variants not covered here, and some do not accept all of these on all securities.
- Exchange rules on trading halts, limit up and limit down bands and opening auctions change how an order behaves in fast markets, and they are outside this lesson.
- Nothing here is advice about any security, and no order type reduces the risk of owning a business.