Strategies for Using a Market Order to Buy or Sell Stock
When you place an order to buy or sell a stock, that order goes into a processing system that places some orders before others. The stock markets have become almost completely automated, run by computers that do their work based on a set of rules for processing orders.
If you want your order processed as quickly as possible and will take whatever price the market gives you, then you can enter your transaction as a market order.
Defining a Market Order
A market order to buy or sell goes to the top of all pending orders and gets executed almost immediately, regardless of price. Pending orders for a stock during the trading day get arranged by price. The best ask price, which would be the highest price, sits on the top of that column, while the lowest price, the bid price, sits on the bottom of that column.
As orders come in, they are filled at these best prices. If an order with a better bid price comes in, it goes to the top of the list.
When a market order is received, it essentially cuts in line ahead of pending orders, and it gets the highest or lowest price available. In other words, when you submit a market order to buy a stock, you pay the highest price on the market. If you submit a market sell order, you receive the lowest price on the market.
Downsides to Market Orders
In most cases, you should avoid using market orders. Not only will you pay top dollar or sell for the bottom price, but you will also pay for a little mischief known as slippage. Slippage occurs when a market maker changes the spread to their advantage on market orders. In other words, beware that you pay a small premium if you use market orders to buy and sell. That premium goes to the market maker as profit.
You can calculate slippage as the difference in the bid-ask spread from the time you enter an order to the time it gets filled. Another form of slippage involves the market maker changing the price to take advantage of an upcoming market order.
When to Place a Market Order
While market orders aren't usually the preferred orders of savvy investors, there are situations when it makes sense to place one. If you are caught in a bad position and the market is moving against you, it's time to bail out in a hurry by using a market order. You don't need to worry about slippage, because the market is moving quickly, and there's more risk in waiting longer to act.
Most investors are particularly concerned with controlling entry and exit prices. There will be times when buying or selling the stock quickly becomes more important than price, but don't let your emotions get the better of you, especially if you're watching a hot stock on a good day. It becomes dangerous when you use market orders to grab shares solely because you've convinced yourself that you have to own a hot stock at any cost.
Thanks to high-speed innovations, small market orders can zip into the market without much warning and be filled. Most investors won't be concerned with a few cents of loss to slippage, but you must be careful, or it can be much worse than pocket change. Also, keep in mind that the slippage applies to each share traded, so the effect is multiplied by the volume of your trade.
How to Place a Market Order
When you place a market buy order, you're saying that you want to buy the stock regardless of price. If you were giving a verbal order to your stockbroker, it might go like this:
"Buy 200 shares of IBM at the market price."
You would use the same process to sell a stock at the market price: "Sell 200 shares of IBM at the market price."
With an online broker, you'll see an option to change the order type on the order screen. Many apps and online brokers will default to a market order, but it's important to double-check the order screen to ensure that you're making the correct kind of order. If the stock is actively traded, a market order placed online will be filled almost instantly, unless there is an unusually high volume of trading in that particular stock at that particular moment. However, in today's fast-moving market, even the near instantaneousness of an online order isn't fast enough to guarantee that you've locked in the price at which you placed your order.
In most cases, you will get close to the buy or sell price you saw when you entered the market order. However, if that particular stock has high activity, you may receive much less or pay much more. While your market order will jump ahead of many pending orders, it will still have to wait for any previously submitted market orders. Each market order that was entered earlier will execute before your order, and each execution affects the stock price. The more orders that are scheduled to process before yours, the more you run the risk of the stock's price changing dramatically.
The Bottom Line
Even if it executes immediately, a market order to buy will have you paying the highest price out of all the existing sell orders, and a market order to sell means you will get the lowest price from the existing buy orders.
For a stock that trades in a narrow range, a market order may not penalize you much. However, when the stock is drawing a lot of activity, you may find that a strategy built upon market orders becomes a buy-high/sell-low strategy. Reserve use of market orders for trades that need to happen quickly, with less priority given to price.