Securities: Equity Market Order Types

Types of Orders

Market Orders

Market orders are buy or sell orders that are to be executed immediately at current market prices. For example, our investor might call her broker and ask for the market price of FedEx. The broker might report back that the best bid price is $90 and the best ask price is $90.05, meaning that the investor would need to pay $90.05 to purchase a share, and could receive $90 a share if she wished to sell some of her own holdings of FedEx. The bid–ask spread in this case is $0.05. So an order to buy 100 shares "at market" would result in a purchase at $90.05, and an order to "sell at market" would be executed at $90.

This simple scenario is subject to a few potential complications. First, the posted price quotes actually represent commitments to trade up to a specified number of shares. If the market order is for more than this number of shares, the order may be filled at multiple prices. For example, if the ask price is good for orders up to 1,000 shares, and the investor wishes to purchase 1,500 shares, it may be necessary to pay a slightly higher price for the last 500 shares.

Notice that depth is considerably higher for the large stocks in the S&P 500 than for the smaller stocks that constitute the Russell 2000 index. Depth is considered another component of liquidity. Second, another trader may beat our investor to the quote, meaning that her order would then be executed at a worse price. Finally, the best price quote may change before her order arrives, again causing execution at a price different from the one at the moment of the order.

Price-Contingent Orders

Investors also may place orders specifying prices at which they are willing to buy or sell a security. A limit buy order may instruct the broker to buy some number of shares if and when FedEx may be obtained at or below a stipulated price. Conversely, a limit sell instructs the broker to sell if and when the stock price rises above a specified limit. A collection of limit orders waiting to be executed is called a limit order book.

Notice that the best orders are at the top of the list: the offers to buy at the highest price and to sell at the lowest price. The buy and sell orders at the top of the list—$90.04 and $90.05—are called the inside quotes; they are the highest buy and lowest sell orders. For FedEx, the inside spread at this time was only 1 cent.

Note, however, that order sizes at the inside quotes can be fairly small. Therefore, investors interested in larger trades face an effective spread greater than the nominal one because they cannot execute their entire trades at the inside price quotes.

Stop orders are similar to limit orders in that the trade is not to be executed unless the stock hits a price limit. For stop-loss orders, the stock is to be sold if its price falls below a stipulated level. As the name suggests, the order lets the stock be sold to stop further losses from accumulating. Similarly, stop-buy orders specify that a stock should be bought when its price rises above a limit. These trades often accompany short sales (sales of securities you don't own but have borrowed from your broker) and are used to limit potential losses from the short position. Short sales are discussed in greater detail later in this chapter.

This article takes inspiration from a lesson found in FIN 4504 at the University of Florida.