Trading platforms offer multiple order types, each with different execution mechanisms, advantages and disadvantages. Understanding what these orders are and how they work is crucial to being successful when trading or investing in the financial markets.
In this article, we are going to explore one of the most commonly used order types - the market order. In addition to exploring the meaning of market order, we are also going to look at a hypothetical example, delve into the downsides of this order and compare it with another very popular order type, the limit order.
What is a market order?
A market order is an order instructing the stockbroker to purchase or sell the units of an asset at the best possible price currently available in the market. Traders and investors widely use this order type, along with the limit order, when buying and selling on stock exchanges.
How does a market order work?
A market order is a trading instruction to buy or sell a stock immediately at the best available current market price. When an investor places a market order, the priority is speed, ensuring the trade is executed as quickly as possible, though the exact price is not guaranteed. Market orders are ideal in highly liquid markets where price fluctuations are minimal. They are typically used when the investor prioritizes executing trades promptly, even in volatile conditions where stock prices can change rapidly. This mechanism ensures efficient trade execution, making it suitable for active traders and beginners alike.
Market order - An example
Let’s understand the concept of a market order with an example. Suppose you want to purchase 50 shares of a company priced at ₹100 each. When you place a market order, the broker will immediately process the order and purchase shares at the current price. However, if there’s high demand for the stock and no sufficient sellers at ₹100, the next available shares priced at ₹101 or ₹102 will be bought. This could result in a slightly higher overall cost for the order. A similar approach applies when selling shares in the market.
Downsides of market orders
Simply being aware of the meaning of market order and how it works is not enough. You must also get to know the various downsides of such orders. Here is a quick overview of some of the key drawbacks of market orders.
- Lack of control over the price
With market orders, there is no guarantee of the exact price at which the trade is likely to be executed. The trade will be executed automatically at whatever the best possible price is at the time of placing the order. This could turn out to be a major disadvantage if you are very particular about the entry price. - Volatility risk
Market orders may expose you to volatility risk, especially if you use them during market gap situations or when the prices are fluctuating wildly and unpredictably. This could lead to market orders executing trades at unfavourable prices.
For example, assume there is a volatile asset with sharp price swings. By the time you place a market order, even if it only takes a few seconds, the price could have moved significantly. Persisting with market orders in such a scenario could lead to your trade getting executed at a very unfavourable price, leading to severe losses.
Pros and cons of market order
Market orders come with certain advantages and limitations:
Pros:
- Fast execution: Ensures immediate transaction completion.
- Simplicity: Easier to execute, making it great for beginners and active traders.
- Best for liquid assets: Ideal for trading high-volume stocks with minimal price fluctuations.
Cons: - Price uncertainty: Prices may vary during execution, especially in volatile markets.
- Unfavorable prices: Not suitable for illiquid stocks with limited buyers or sellers.
- Risk of slippage: The final trading price might be higher or lower than expected.
Market order vs limit order
Now that you know what a market order is, let us compare it with its counterpart, the limit order, to try and understand how they differ from each other. Here is a table outlining the differences between the two.
| Particulars | Market order | Limit order |
| Execution price | Executes trades at the best possible price | Executes trades at the price specified by you or a better price |
| Control | No control over the price at which the trade is executed | Full control over the price at which the trade is executed |
| Guarantee | Guarantees the execution of the trade | Does not guarantee the execution of the trade |
| Speed | Gets executed immediately, provided there are enough buyers and sellers on the market | May or may not get executed immediately; there is usually a delay in trade execution |
| Volatility risk | Exposes you to volatility risk | Protects you from volatility risk |
Also read: What are growth stocks?
Conclusion
With this, you must now be aware of what a market order is, how it works and its downsides. A market order could be a very useful tool for those looking for immediate trade execution, even if it means compromising on the price.
However, using market orders in highly volatile or illiquid situations could potentially lead to significant losses. Therefore, it is advisable to thoroughly consider the advantages and risks that market orders pose before using them as part of your trading and investment strategy.
