Investors must specify how a trade will be performed when they request to buy or sell a security. We’ll discuss four different order types in this unit:
Market orders
Limit orders
Stop orders
Stop limit orders
Market orders, which are appropriate for investors seeking immediate executions, are discussed in this chapter. This order type does not specify a price and goes through at the next available market price. In the real world, market orders typically fill within a few seconds of placing the order.
When a market order is placed, execution is guaranteed, meaning the customer’s transaction request is guaranteed to occur. However, the price is not guaranteed. This presents a risk for a customer, especially if the market order is placed when the market is closed.
Assume an investor places a market order to buy stock in a pharmaceutical company after the market closes when the stock price is $50. A few hours later, a news article about the company curing cancer is published, and the stock price skyrockets to open at $200 the next day. If the investor’s order is still in place at the market open, they will pay 4x the amount they likely expected to pay. Although scenarios like this are relatively rare, it’s common for stock prices to fluctuate overnight.
It could go the other way too. Assuming we’re still discussing our $50 stock, a customer faces some risk if they place a market order to sell when the market is closed. The stock price could fall significantly overnight, resulting in a sale at a much lower price. For this reason, investors generally avoid placing market orders overnight.
When an order is placed, customers must specify the time the order covers. Generally speaking, orders can be day orders or good-til-canceled (GTC). Day orders are canceled at the end of the day if they remain unexecuted. GTC orders are only canceled once the customer requests, which could be days, weeks, or months. Market orders always go through instantly, so broker-dealers automatically default their timeframe to day orders.
Here’s a video that dives further into market orders:
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