What is Market Order? How does It Work, Market Order vs Limit Order & Example

Table of Contents:              

What is Market Order?

Types of Market Orders

How does a Market Order Work?

Market Order vs Limit Order

Advantages and Disadvantages of Market Order

Example of Market Order

What is Market Order?

A market order is a type of order to buy or sell a financial instrument, such as stocks, bonds, or commodities, at the current market price. When you place a market order, you are instructing your broker or trading platform to execute the trade immediately at the best available price.

The key characteristic of a market order is its speed of execution. Since it is designed to be executed quickly, the price at which the order is filled may not be the exact price at the time the order was placed. Instead, the execution price is determined by the prevailing market conditions and the available liquidity. As a result, the actual execution price of a market order may vary slightly from the displayed or quoted price.

Market orders are often used when traders want to enter or exit a position promptly and are less concerned about the specific price at which the trade is executed. They are especially useful in highly liquid markets where there is a high trading volume and tight bid-ask spreads.

Types of Market Orders:

Market orders are a type of order used in financial markets to execute a trade at the best available price. When placing a market order, you are instructing your broker to buy or sell a security immediately at the prevailing market price. Here are the main types of market orders:

1. Buy Market Order: This is a simple order to purchase a security at the best available market price. The order is executed as soon as possible, and the buyer accepts the prevailing ask price.
2. Sell Market Order: This type of market order instructs the broker to sell a security at the best available market price. The order is executed promptly, and the seller accepts the prevailing bid price.

Market orders are generally executed quickly since they prioritize speed over price. However, it’s important to note that the actual execution price of a market order may vary from the quoted price at the time of placing the order due to market fluctuations and liquidity conditions.

How does a Market Order Work?

Here’s how a market order works:

1. Placement of the Order: You decide to place a market order to either buy or sell a specific security, such as a stock or a bond. You specify the quantity of the security you want to trade (e.g., the number of shares).
2. Order Routing: You submit the market order to your broker or enter it through an online trading platform. The order is then transmitted to the relevant exchange or market where the security is traded.
3. Execution at Best Available Price: Upon receiving the market order, the broker or the exchange executes it as quickly as possible at the best available price in the market. For a buy market order, the broker will look for the lowest ask price available from sellers. For a sell market order, the broker will seek the highest bid price from potential buyers.
4. Filling the Order: The market order is filled by matching it with existing orders in the market. If you placed a buy market order, your order will be matched with existing sell orders from other market participants. Conversely, if you placed a sell market order, your order will be matched with existing buy orders.
5. Confirmation of Execution: Once the market order is filled, you receive a confirmation from your broker or trading platform, indicating the details of the executed trade, including the quantity, price, and any applicable fees or commissions.

Market Order vs Limit Order:

Market Order: A market order is an order to buy or sell a security at the current market price. When you place a market order, you are instructing your broker to execute the trade immediately at the best available price in the market. The execution of a market order is typically fast, as it aims to prioritize speed over the specific price. However, the actual execution price may differ from the quoted price at the time of placing the order due to market fluctuations and liquidity conditions.

Limit Order: A limit order is an order to buy or sell a security at a specific price or better. Unlike a market order, a limit order allows you to set a specific price at which you are willing to buy or sell. If you place a buy limit order, it will only be executed if the market price reaches or falls below your specified limit price. Similarly, a sell limit order will be executed if the market price reaches or exceeds your specified limit price. Limit orders provide you with more control over the execution price, as they allow you to define a price threshold at which you are willing to trade.

Differences Between Market Order & Limit Order:

1. Execution Price: A market order is executed at the prevailing market price, while a limit order is executed at or better than the specified limit price.
2. Speed of Execution: Market orders are typically executed quickly, as they prioritize immediate execution. Limit orders, on the other hand, may not be executed immediately and can remain open until the market price reaches the specified limit price.
3. Price Control: Market orders prioritize execution speed over price control, while limit orders provide more control over the execution price by allowing you to set a specific price at which you are willing to trade.
4. Certainty of Execution: Market orders are more likely to be executed, as they aim to trade at the best available price. Limit orders may not be executed if the market price does not reach the specified limit price.

Advantages and Disadvantages of Market Order:

Advantages of Market Orders:

1. Speedy Execution: Market orders are executed quickly since they prioritize immediate execution at the best available market price. This can be advantageous when you need to enter or exit a position swiftly.
2. High Probability of Execution: Market orders are highly likely to be executed since they seek to buy or sell at the prevailing market price. As long as there is sufficient liquidity in the market, your order should be filled promptly.
3. Simplicity: Placing a market order is straightforward. You simply specify the quantity of the security you want to buy or sell, and the order is executed at the current market price. There is no need to set a specific price or worry about price fluctuations.

Disadvantages of Market Orders:

1. Lack of Price Control: Market orders do not guarantee a specific execution price. The actual price at which your order is filled may differ from the quoted price at the time of placing the order due to market fluctuations or changes in liquidity. This can result in slippage, where you may end up buying at a higher price or selling at a lower price than anticipated.
2. Price Volatility: Market orders are susceptible to price volatility, especially in fast-moving markets or during periods of low liquidity. If the market experiences sudden price swings, you may end up with a less favourable execution price.
3. Potential for Large Price Gaps: In highly volatile markets or when trading illiquid securities, there is a risk of encountering significant price gaps between the quoted price at the time of placing the order and the actual execution price. This can occur if there is a lack of available buyers or sellers at the desired price level.
4. Limited Control: Market orders offer limited control over the execution process. Once the order is placed, it is executed at the best available price, regardless of any changes in the market conditions or your desired execution parameters.

Considering these advantages and disadvantages, market orders are suitable for traders and investors who prioritize speed of execution and are willing to accept the prevailing market price. However, if you require more control over the execution price, limit orders or other order types may be more appropriate.

Example of Market Order:

Let’s say you’re monitoring the stock of Company XYZ, and you decide to purchase 100 shares of XYZ at the current market price using a market order. The current market price of XYZ is $50 per share.

You contact your broker or use an online trading platform, and you place a market order to buy 100 shares of XYZ. Your broker receives the order and executes it immediately at the best available price in the market.

If the market is highly liquid and there are willing sellers at the current market price, your market order will likely be filled promptly. In this case, your broker finds sellers offering XYZ shares at or near $50 per share, and they are matched with your buy order.

The execution of the market order could happen in a matter of seconds, and you would end up owning 100 shares of XYZ at the prevailing market price.

Summary: Its palpable to note that execution price of a market order may differ from the quoted price at the time of placing the order due to market fluctuations and changes in liquidity. Additionally, in fast-moving or illiquid markets, there is a possibility of encountering slippage, where the execution price deviates significantly from the expected price.

Market orders are typically executed quickly since they prioritize speed of execution over the specific price. They are suitable when you want to enter or exit a position swiftly and are ready to accept the prevailing market price at the time of execution.

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