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.
Why use a market order?
With the meaning of market order out of the way, let us look at why you should use this order type when trading or investing.
Since the instruction is to buy or sell the asset at whatever the best possible price is at that moment, market orders usually get executed immediately without any delay. Therefore, if you wish to execute a trade quickly and are not too specific with the price at which the trade is executed, you could consider placing a market order. Market orders can be very useful when trading in highly liquid assets with low volatility and tight bid-ask spreads, such as large-cap stocks.
Also read: What are small-cap stocks?
Market order - An example
Now that you are aware of what a market order is, here is a hypothetical example to help you understand exactly how it works.
Assume you wish to purchase a mid-cap stock with strong trading volumes. The stock’s current market price is Rs. 1,450 per share. You decide to place a market order to purchase 10 shares. The best possible price at the time of placing the order drops to Rs. 1,446 per share. As soon as you place the market order, it will be executed immediately at Rs. 1,446 per share.
Let us consider another scenario. What if the best possible price of Rs. 1,446 per share is only for 5 shares? The market order, in this case, will move onto the second-best price. Assuming the second-best price is Rs. 1,448 per share, the remaining 5 shares will be purchased at this price. This would bring your total investment cost to Rs. 1,447 per share.
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.
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.
