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Choosing Market Order or Limit Order

Choosing Market Order or Limit Order
July 07
23:07 2011

There will come a time – maybe early in your trading career, maybe on a day that saps your confidence after years and years of successful trading – when you’ll know you want to place a trade, but you’ll hesitate. Should it be a limit order? A market order? Just for today’s session? Or good until cancelled? And the hesitation can be a very bad thing if the environment is just wrong.

So it makes sense to take a moment and review why these different order types exist and how they can be used in your own trading program. By being ready when the opportunities present themselves, you’ll add the extra penny or two to your account, or maybe even make the difference between a winning trade and a losing one.

A market order is the simplest type of order. All it’s telling the market is that you want to either buy or sell a particular financial instrument. Except under the most extreme market conditions, a market order will always achieve what you set out to do. That is to say, if you want to buy that instrument and you place a market order, by golly, you’ll get that instrument. But at what price? Therein lies the risk of placing market orders: they will be immediately filled at the “best price available” on the exchange, but at the instant your market order gets filled, that “best price” could be many ticks away from what you had in mind, or what was showing up on your trading screen at the moment you placed the order. In a fast moving market, or in a market with low liquidity and a wide, choppy bid-ask spread, placing market orders can expose you to a considerable amount of slippage in your trading program.

A limit order, on the other hand, allows you to be more precise. Not only do you have to specify the instrument you want to trade and whether you want to buy or sell it, you must also dictate the price at which you want the transaction to occur. If the market never moves to that price (i.e. no offers ever move low enough to match your bid, or no bids ever move high enough to match your offer), the trade just won’t take place. It’s common for limit orders to be entered as “good until cancelled” (GTC), because a trading program may be set up to buy an instrument at a specific price, no matter how long it takes for the market to reach that price. Even then, you’ll never be guaranteed to ultimately own (or sell) that instrument if you place a limit order, and that opportunity cost is the risk of using them.

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Whether setting up a new trading program or just making one-off trades, it’s important to choose the correct type of trade. Each has its benefits (market orders lead to certain, immediate fills; limit orders achieve a certain price) and its drawbacks (market orders can lead to slippage; limit orders may never get filled). So each has its time and place, even in a highly-disciplined trading program, and it takes some analysis to determine which type of order is most appropriate for a specific market, a specific day, and a specific trading goal.


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