The Importance Of Limit Orders
Many average investors do not understand the difference between a market order and a limit order. When buying or selling a stock, the difference is huge. Using a market order instead of a limit order could cost you big. Market orders give you whatever price the stock is being offered at when your order reaches the electronic market place. A limit order gives you a specific price of your choosing.
Why A Market Order Is Risky...
Market orders are most risky for investors on thinly traded stocks (small caps). For average investors, this often times allows for a bad entry price when there is a wide spread. The spread is the difference between the bid and the ask (what buyers are willing to receive and what sellers are willing to pay. A market order entry on a stock with a bid of $2.20 and an ask of $2.40, with a last print of $2.25 will be $2.40. This is horrid for the investor or stock trader. On larger stocks like Apple Inc (AAPL), the algorithms can cause entries to be multiple pennies worse by pulling the offers in the split second between when you click the market buy button and when the order actually hits the market and gets filled. For instance, the spread on a stock could be $50.05 x $50.07. An investor doing a market order thinks they will get $50.07 but just as they click the buy button, the $50.07 gets pulled and it gets filled at $50.10. This happens millions of times a day as the algorithms look to capitalize on millisecond moves they can create.
Why A Limit Order Is Best...
A limit order on the buy or sell side gives control to the investor or stock trader. It takes control away from the institutions. If you put a limit buy order at $5.00, the only price you can get filled at is $5.00 OR better. This means you know your worst case scenario is $5.00 as an entry price. The algos cannot play games, the spread does not matter, you decide your entry price. There is always a chance you do not get filled, but having control is much more important as an investor.
How I Handle Trading With Limit Orders...
I ALWAYS use limit orders to buy and sell stocks. I have traded for 25+ years and this is the key. When a stock is trading with a bid of $25.45 and $25.47, and I want to buy it this second, I use a limit order. I place my limit order at $24.47 (at the ask). This ensures that I get the shares being sold there but if the algos play any games, I will not fall into the trap and get a worse price. In addition, by using a limit order, the algos know not to play games because I will not take a higher fill. Sometimes, I even get a better fill. This is a way to take the shady games away from a stock and the institutions. On a small cap that is thinly traded, I always use limit orders as well. With a stock trading at $2.20 bid by $2.40 ask, I will usually put my order at $2.21. This ensures that any seller will fill me first, since I am top bid now. I also use a little known tactic that most advanced trading platforms have. They allow you to only ‘show’ a certain amount of shares on the level II (which other investors can see). If I want to buy 10,000 shares, I will only show 500 shares on the bid at a time. This keeps other investors from front running me, seeing the big size buy.
Using limit orders for stock trading and investing is by far the smartest thing you can do. Over time it saves you thousands if not millions of Dollars.
Gareth Soloway
Chief Market Strategist
InTheMoneyStocks.com
