Market or limit orders

All orders can be divided into two broad groups—market and limit orders. A market order is filled at what brokers like to call the best price—but what is in fact any price and often the worst price. An alternative to a market order is a limit order. It demands an execution at a specific price—or no execution at all. A limit order helps you avoid slippage.

A market order guarantees you an execution but not the price. A limit order guarantees you the price but not the execution. You must choose one or the other because you cannot have both in the same trade. You have to decide what is more important to you—an execution or an avoidance of slippage? You may answer this question differently at different times, depending on what you are trying to accomplish.

Suppose you’ve bought 1,000 shares of a $19 stock, and your research indicates that if it declines to $17.80, the uptrend will be over. You call your broker or log into his website and place a stop order to sell 1,000 shares at $17.80, good until cancelled. Normally, a stop order is placed below the market as an MIT order—“market if touched.” If you put your stop at $17.80, it will become a market order to sell 1,000 shares the moment that stock trades at $17.80. Your position is now protected. You can go about your life and feel less worried about that stock.

A market order is a slippery thing. In a quiet market, you may get filled at $17.80. Occasionally, you may get very lucky, and if prices bounce after touching $17.80, you may get filled at $17.81 or $17.82. What is much more likely to happen, however, is that during a sharp downdraft the stock does not linger long enough at $17.80. You put your MIT stop at $17.80, but when you get your fill, it is at $17.75. This slippage on 1,000 shares has just cost you $50—probably several times larger than your commission.

Prices move smoothly only in quiet markets but they can jump across several price levels when the action heats up. Putting an MIT order at $17.80 does not guarantee you’ll be filled there. In a fast decline you may suffer slippage and get filled at $17.78, $17.75, or even lower. If a sudden piece of very bad news hits your stock, it may gap all the way down to $16, or even lower.

A stop is not a perfect tool for protecting your profits or reducing losses—but it is the best tool we have. Stung by slippage, some traders switch to limit orders. They order to sell only at a specified price, using a limit order for their stop. I strongly disagree with this tactic.

I almost always use limit orders for entering trades and taking profits at target levels. A limit order says, in effect, “my way or the highway.” I will only do business at a level that suits me, and will not accept slippage on an entry or on profit-taking. If I miss entering a trade as a result of a limit order, I do not complain—there will be many other trades in the future. If you try to enter a trade using a limit price and do not get filled, you lose nothing.

The situation with protective stops is completely different. If you miss an exit from a trade, you can get caught in a waterfall decline. A trader can lose a lot while fiddling with limit orders, trying to save a few pennies. When the trouble hits, run without haggling. That is why I use limit orders for entries and profit-taking but switch to MIT orders when using stops.

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