Order types
A market order guarantees execution, not the price. A limit order guarantees the price, not execution. That one distinction explains almost everything.
A market order says: buy right now, whatever the price. It almost always executes, but you won't know exactly what price beforehand.
A limit order says: buy at this price or better. You set the ceiling. In exchange, it might never execute at all, because the price never gets there.
A stop order is something different, and often confused with the others. It sits below the current price and only activates once that price is reached. At that point it becomes a market order. It's for exiting, not entering.
Rule of thumb for beginners: with thinly traded assets and in volatile phases, always work with a limit. A market order in a thin market can execute at a price considerably worse than what you just saw.
Market orders take liquidity out of the order book and get matched against the best available counter-orders. If volume at the best price level isn't enough, execution continues against worse levels, which makes the average execution price deviate from the displayed one. That effect grows with order size relative to available depth.
Limit orders supply liquidity and get placed into the order book. The downside is execution risk plus adverse selection: a limit order tends to get filled precisely when the market moves against it. Both order types therefore systematically trade price certainty for execution certainty, one way or the other.
For stop orders, the trigger needs to be separated from the execution price. Once the trigger threshold is reached, a market order is generated, and its execution can land considerably below that in a price gap. A stop-limit order caps that effect, but can go completely unfilled in a fast-falling market, which defeats its protective purpose. The choice between the two is a trade-off between execution certainty and price certainty in the worst case.
Summary
- Market guarantees execution, limit guarantees the price.
- A stop order becomes a market order once triggered.
- In thin markets, always work with a limit.
Did you get it?
What does a limit order guarantee, and what doesn't it?
It guarantees a maximum price, but not that it executes at all.
Why can a market order execute worse than displayed?
Because with insufficient depth, it gets filled against worse price levels.
What's the downside of a stop-limit order?
In a fast-falling market, it can go unfilled entirely, offering no protection at all.
Related
- Spread, slippage, and liquidityStage 1
- Your first orderStage 1
- Understanding the trading interfaceStage 1