Monday, June 6, 2011

Basics of Stock Orders - I: The Market Order

Well after my final exams, I think it's finally time to start posting regularly again!

Today I would like to supplement my previous series, The Basics of Stocks, with a new series: The Basics of Stock Orders.

When executing any stock trade, there are a variety of different orders from which you can choose. Many of these stock orders are confusing for new investors, so I would like to cover them all in separate posts. Today, we will be covering one of the most popular orders: the Market Order.

With a Market Order, there is no haggling on the price since the Market Order will purchase the stock at the best possible price available on the market--thus
getting the stock into your account as quickly as possible.
Image Source:

What is a Market Order? Essentially, it is a stock order where you prioritize time over price.

Consider the following scenario: suppose you are planning on purchasing Google stock one day. Suppose that it is 3:50 PM and the stock market is close to closing at 4:00 PM. During this time, there is a lot of volume on the NASDAQ, which consequently also means that the price will fluctuate a lot during this brief time period.

If you are really optimistic on Google stock and expect it to appreciate, then you will want to purchase the stock as cheap as possible. However, remember that during the last 10 minutes of the day the stock price is fluctuating quite a lot, and your trade may not get executed at the exact price which you want. Suppose Google had been trading at around $519-$526 a share during the day, and more around $521 during the end of the day (from 3:30 PM onwards). From 3:30 PM onwards, the stock may fluctuate rapidly between $521 ± $1, which may not seem drastic but is indeed a big difference when you are purchasing many shares at once.

If you expect Google stock to appreciate, you would want to own to own it as soon as possible at the best possible price; considering this situation coupled with the final minutes of trading, a Market Order may be a viable stock order.
Image Source: Yahoo! Finance

Additionally, keep in mind that you expect Google stock to appreciate, and thus you want to own shares today. Because of your optimism on the stock's performance, coupled with the time (3:50 PM, 10 minutes from the NASDAQ closing), there is very little space for you to get the price you want as well as your trade executing (remember, in a stock trade there must be a buyer and a seller).

It is during this time that a Market Order will be most beneficial. The Market Order, unlike a Limit Order (which I will cover in the post following this), prioritizes time over price. This means that the Market Order is indifferent on the price of Google stock on the market--it simply wants to get you the stock in your hands as soon as possible (as you want to own it today because you expect it to appreciate either tomorrow, or sometime soon, and purchasing it tomorrow would ruin any profits). Assuming you have sufficient money in your account, the Market Order will execute at the best possible price available on the market.

A Market Order prioritizes speed over price, making it a good order for investors looking for a fast executing order during final minutes of trading.
Image Source:

The Market Order is an instantaneous order which does not require specifying a price. So if Google happened to be trading at $521.30 the moment right before you executed the Market Order, you may end up buying Google at $522.10, since that may be the best possible price available that instant in which the order was executed (keep in mind that there are thousands of other orders coming in simultaneously during the last 10 minutes of the market). The downside to this is of course, that you purchased the stock for a higher price than you could have gotten it if you had specified your price and waited for the stock to trade at that price. The upside to this however, is that your order was executed instantaneously and thus you own the stock albeit purchasing it for a higher price.

In summary, the Market Order is an instantaneous stock order which has an upside and a downside:

Upside: A Market Order is instantaneous and will purchase the stock at the best possible price available on the market, thus getting the stock in your hands faster than any other order.

Downside: The Market Order is price indifferent--meaning that you may end up purchasing the stock for a higher price rather than a lower price. This may cut in on your profits, but assuming that owning the stock was your priority, this downside is worth the risk.

The Market Order is a very popular order and is often used when an investor prioritizes owning a stock over the price paid for the stock. Paired with other stock orders, the market order can be a wise order given the right circumstances and conditions.

Look forward to my upcoming post on Limit Orders!

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