Why Limit Orders May Cost More Than Market Orders

There are several ways that investors can buy and sell securities. Investors can choose to make a simple order by going with the current price and making a quick trade. Another type of trade focuses on the price. This means that the trade isn't executed until it reaches a certain price limit. These are referred to as market orders and limit orders, respectively. In this article, we review market and limit orders, and why limit orders cost more.

Market Orders vs. Limit Orders

As noted above, market orders and limit orders are two different types of orders that investors can make when they want to buy and sell securities, such as stocks and bonds. Let's take a look at how these two differ.

Market Orders

Investors who want to execute quick trades do so through market orders. When people think of buying and selling tradeable assets, market orders are usually what come to mind. As such, these orders are considered the default transaction.

Since they focus primarily on speed of execution, the price of the security takes a back seat. Investors alert their broker to complete the transaction as quickly as possible at the best available price. It's just like selling a house at the market price (rather than negotiating or waiting for a higher offer) because you need to close the deal immediately.

When the trader requests a market order, it is processed immediately at the security's current market price. Orders placed after hours are executed the next business day. While the trade is guaranteed, the price isn't. That's because of the potential for lags and delays that may prevent traders from getting the price quoted at the time the transaction is requested.

Limit Orders

A limit order is different from a market order. While the latter focuses on quick trades, limit orders focus on the security's price. Investors who choose to buy and sell using limit orders do so by setting a limit on the price. This is akin to negotiating for the best possible deal for a big-ticket item and only signing a contract until the buyer or seller meets your requests.

Traders who use limit orders decide the minimum or maximum price at which they wish to buy or sell specific financial securities. So:

• A buy-limit order goes through when the price reaches the limit price or a lower one.
• A sell-limit order goes through when the price reaches the limit price or a higher one.
  

As such, this type of order guarantees that an order is filled at or better than a specific price. It doesn't necessarily guarantee, though, that the order will be filled. That's because it is usually only valid for a certain number of days or until the trader cancels the order. And there may be orders already in the queue, which could leave fewer sellers willing to fill yours.

Market and Limit Order Trading Fees

Market orders are considered the simplest and most guaranteed way to buy and sell securities. As a result, brokerage fees for market orders are often lower compared to other types of orders, such as limit orders. Limit orders tend to be more complicated, which is why they often come with higher fees.

With a limit order, the investor is allowed to specify the maximum price at which they will purchase security or the minimum price at which they are willing to sell it. This type of technical trading gives the investor more control, as they are not entirely subject to the market's whims. As such, trades are only executed when they can be made at prices pre-approved by the investor.

Limit orders may cost more and command higher brokerage fees than market orders for two reasons.

1. They are not guaranteed so if the market price never goes as high or low as the investor specified, the order is not executed.
2. Because they are more technical and less straightforward trades, they create more work for the broker. The broker then charges the investor a higher fee to compensate.

Most brokerages offer free or low-cost online trades on stocks across various order types for customers who perform trades without the assistance of a broker or trader.

The Bottom Line

Making a trade can be as simple as placing a market order or it can be a little more complicated by requesting limit orders. Investors who want to buy and sell securities immediately place market orders while those who place limit orders are concerned with buying and selling their assets within a certain price limit. Because of their complex nature, limit orders tend to be more costly. Keep in mind that because traders wait for the price to reach a certain limit, they must be wiling to accept the risk that their trades won't be fulfilled.