Strategies for Using a Market Order to Buy or Sell Stock

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••• Enter the market order to take the right advantage. Biddiboo/Photographer's Choice/Getty Images

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 would enter your buy/sell 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 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 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.

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 his advantage on market orders.

This is a questionable practice, but beware that you may pay a small premium, which is the market maker's extra profit if you use market orders to buy and sell securities.

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 making a change in price to take advantage of an upcoming market order.

When to Use Market Orders

When does a market buy or sell order make sense? 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 and not worrying about slippage.

Most investors are very concerned with controlling entry and exit prices; however, as noted above, there will be times when buying or selling the stock quickly becomes more important than price. It becomes dangerous when you convince yourself that you have to own a hot stock at any cost and use market orders to grab shares.

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' loss to slippage, but you must be careful or it can be much worse than pocket change.

Placing 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 market.

Assuming you use an online broker, you'll see the order entered on the order screen. If the stock is actively traded, a market order will be filled almost instantly unless there is an unusually high volume in this particular stock. However, in a fast-moving market even almost instantly isn't fast enough to ensure the price at which you placed your order is the exact price you receive.

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 get much less or pay much more.

If other market orders are in front of yours (entered before yours), you run the risk of the stock's price changing dramatically.

Even in normal market conditions, when you enter a market order to buy you will pay 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 a market order 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.