Thursday, April 12, 2012

No More Market Orders

I used to make most of my stock trades as market orders. This meant that the broker just executed my buy or sell order at the best available price right away. However, I now make limit orders exclusively to avoid getting burned by unusual market conditions.

The exact price on stock trades isn’t as important for buy-and-hold investors as it is for high-speed traders. A few cents per share spread over a decade holding period isn’t a big deal. However, unusual market conditions can lead to surprises.

To use a concrete example, if you place a market order to sell 200 shares of VCE when its spread is $24.87 to $24.88, you expect to get $24.87 per share. However, this is not guaranteed. If there is a sudden change in the market, you could end up getting less. How much less depends on how violently the market shifts.

A simple remedy is to place a limit sell order at, say $24.85. You are still very likely to get $24.87 per share, and you are guaranteed not to get any less than $24.85. The exact price to choose for the limit is the lowest price you are willing to accept if there is a sudden shift in the market.

My excuse for getting into the habit of making market orders is that it used to cost me $25 per market order trade and $29 for a limit order trade. Now that I pay about $10 per trade and there is no extra cost for a limit order, I no longer have any reason for using market orders.

I still sometimes forget to include a limit with my orders, but an article about “hide-not-slide” orders reinforced for me the lengths active traders will go to take money from each other. I can’t say that I fully understand the purpose of these hide-not-slide orders, but they have helped me to remember to protect myself with limit orders.

6 comments:

  1. One thing about limit orders is that there is always a chance of missing the target price by only a cent or two.
    This has happened to me more than once...it can be very annoying.

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  2. Congratulations on joining the rational world.

    Hazy: Did it occur to you that market orders are encouraged by brokers to ensure earning a commission?

    Your comment about missing a trade assumes that you KNOW that this is the BEST TIME to trade and that if you do not buy it RIGHT NOW something bad will happen. Nonsense.

    And if you still fear missing a trade, just bid - with a limit price that is above the offer. But do not use a market order.

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  3. @Hazy: I should make it clear that I'm not trying to save a penny here or there. I actually set my limits outside of teh current spread as protection against violent moves.

    @Mark: I like to think that I'm in the rational world but still trying to correct mistakes (or adjust to a changing world :-)

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  4. Oh OK,So this is a stop loss kinda thing.
    So you still need to figure out where to put the stop.
    Your example has it only 2 cents below market...I'm guessing VCE pricing doesn't jump around too much.

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  5. I do the same thing: a limit order a penny or two more (or less) than the current ask (or bid). To be fair, there is no guarantee that VCE at $24.85 will be filled either. In a fast moving market, it may not be. However, a limit order is good practice especially with thinly-traded securities.

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  6. @CC: You're right that even limit orders outside the spread aren't guaranteed to be filled. The key is to pick a price that really is the limit of what you're willing to pay or accept.

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