When you want to buy or sell shares in a publicly traded company, you’ll face choices about which stock order type to use. The one you pick depends on the trading scenario and your priorities.

What is a market order?

A market order is an investor’s instruction to buy or sell now, at the best available price.

Here’s an example of a market order: An investor wants to buy 50 shares of Oracle Corp., the big provider of corporate-database software. They give their broker a market order at 2 p.m. to buy 50 shares, when US markets are open and Oracle’s stock price is $86. At the moment the broker executes the trade, the price happens to have risen a bit, to $86.25. That’s the price the investor ends up paying in the open market for the 50 shares.

Market orders are generally preferred by long-term investors who are looking at the fundamental characteristics of companies in buying and selling stocks, and will hold stocks for months and years. Market orders are easy to complete at virtually no cost. Trading price at any particular moment is of less concern to long-term investors.

The primary risk associated with market orders is that they come with price uncertainty. This risk is magnified on days when markets are volatile and with securities that have a large bid-ask spread, because the difference between the investor’s most recent price quote and the actual trading price can be greater.

What is a limit order?

A limit order is an order with a specific price limit. A buy limit order sets a price ceiling: don’t pay more than $XX a share. A sell limit order sets a price floor: don’t sell for less than $XX.

Here’s an example of a buy limit order: An investor wants to purchase 50 shares of Oracle Corp., but they see price fluctuations throughout the day. At 2 p.m. they place a limit order to pay no more than $86 per share, which is fulfilled near the end of the trading day. Had the shares remained higher than $86, the trade wouldn’t have been executed.

Limit orders are favored by traders who focus more on short-term price trends in stocks, and who buy and sell frequently. They’re also favored by those placing large trades, where small price discrepancies can translate into large sums.

The primary risks associated with limit orders are that they either don’t get executed or the limit price is overtaken by events.

Unlike a market order, which is fulfilled as quickly as possible usually within the day, a limit order can be left standing with a broker for a while, sometimes as long as three months.

Market vs. limit orders: Key differences

Market orders are typically used by smaller investors and focus on the following:

• Speed and completion of the purchase or sale, which matter more than a price
• Stocks with large market capitalizations and high liquidity
• Stocks whose bid-ask spread is narrow, typically a few cents a share
• Transactions of fewer than 100 shares
  

Limit orders are typically used by big investors and professional traders, with a focus on:

• Small price discrepancies
• Smaller-capitalization stocks or thinly traded (illiquid) stocks that are not well-known or have had problems
• Stocks that trade at wider bid-ask spreads
• Large number of shares per trade

Choosing between a market and limit order

When choosing which type of order to place, one consideration is the potential for unexpected price swings. Here’s an example.

Imagine a biotechnology startup that’s developing its first drug, a dementia treatment. The company doesn’t yet have any revenue. Its stock closed yesterday at $60 a share. After US trading closes, an investor places a market order online for 50 shares.

Early the next morning, before stock-market exchanges open, the startup announces its success with clinical trials of the drug. The biotech's shares soar in premarket trading, indicating the stock will open at about $90 when exchanges begin trading.

The investor’s market order would mean they probably face a purchase price of $90, unless they cancel the order before exchanges open. They could take a chance that the price opens lower than $90 once markets begin trading. But the shares might also open higher than $90, in which case the investor ends up paying even more.

On the other hand, if they think a lower price is fair, they could place a limit order—say, for $75—and leave it standing for as long as three months. They prefer to be patient, to see if the market enthusiasm wanes and the price retreats to $75, rather than buy at a perceived peak.

The tradeoff is that they’ve imposed some price discipline on their trading. They also don’t need to keep watching the market price; if it falls to $75 or lower, the limit order is triggered and becomes a market order, meaning the investor pays the going price in the market at that moment.

However, one potential risk of limit orders that are left open is that the limit price may get overtaken by events.

Let’s return to the biotech startup example: An investor placed the $75 limit order and left it open for a month. The stock price starts to fall in the next few weeks, to about $77, when news breaks of a setback—federal regulators reviewed the clinical trials and want them repeated because of possible side effects of the drug.

The stock price begins to slide when trading opens, falling past $75 and triggering the limit order to buy at $75. It keeps falling that day, ending at $58. So the limit order cost much more than if the investor had watched and waited before buying.

The bottom line

Market and limit orders each come with benefits and risks, and may make sense in different trading scenarios. Understanding the differences between these order types is important for investors.

• Market orders tend to be used by small investors who are less concerned with minor price disparities that won’t matter much when shares are held for months or even years.
• Limit orders, on the other hand, are critical to short-term investors and traders who move quickly in and out of stocks, and the difference of a few pennies a share can mean an investment makes or loses money. They also are used by large institutional investors, where a minor price difference when buying large amounts of stock can translate into a lot of money.