| Have you ever noticed the advertisements from the discount
on-line Brokers that say $5.00 or $7.00 per trade? Right! We’ve all seen them and wondered how they can
do it. Well, there’s two reasons for this: 1) They sell their order flow to Market Makers (the subject
for a another story and 2) The fine print says "Market Orders".
There’s an old mantra in the day trading community that basically says,
"Never use a Market Order; always use a "Limit" order. In reality, there is a time and
place to use Market Orders, however, it is very limited in scope and requires great care in doing so in
order to prevent from getting stuck with a bad order fill price.
You can better understand why not to use a Market Order if you take a
moment to look at what it really is. A Buy Market Order will be filled from the best available
"Ask" (Seller side of the market) price. A Sell Market Order will be filled from the best
available "Bid" (Buyer side of the market) price. I know, it sounds a little twisted around but
stop and think about it for a moment. When placing Orders in the stock market, Buyers and Sellers are
matched to each other.
This is all well and good however, you never really know exactly how many
Market Orders are waiting their turn (first come, first serve) to be executed.
As shown in the Level 2 screen shot in Figure 1 above, we get to
see the best Bid and Ask Limit Orders from each of the Market Makers and ECNs on the NASDAQ Market.
By-the-way, this information is not available for the New York Stock Exchange (NYSE) yet. We cannot see
all of the orders as these are the "Best" orders however, it gives us a perspective of what is
waiting to execute and it changes constantly.
Most of the time, your average investor doesn’t have the advantage of a
NASDAQ Level 2 display. They only have Level 1 which displays the Best Bid and Ask.
OK, I know, the subject here is Market Orders, not Limit Orders. Right?
Wrong! You can’t talk about one with getting a bit technical about the other. But first, a little
explanation on how to read the Bid and Ask is required.
Now let’s look at our example:
Let’s say that you place a Market Order to Buy 100 shares.
Normally, when looking at Figure 2 you would probably think that your order will be
filled immediately from the Limit Order that is being held by HRZG with a price of 1-1/16.
Right? Well, … maybe. It all depends on how many Buy Market Orders are sitting in front of
your order. Remember, orders are executed on a first come, first serve basis. So, if there are
orders for 100 shares executing in front of yours, your order will be filled from the Market
Maker BRUT.
Now, here’s where Market Orders will get you into real
trouble. If there are orders for 1300 shares executing in front of yours, you will be filled
from the Market Maker SHRP at the higher price of 1-3/32. Well, you say, "that’s OK as
it’s only 1/32 higher so that’s not so bad". Right? No, wrong? Because in the real
world of the market there could literally be Thousands of Market Order shares executing before
you so your price could really be much higher. Especially if the price of the stock is rising
rapidly. The same holds true in the other direction for Selling shares.
Often, we here stories on the News broadcast that a buyer put in a Market
Order when the price of a stock was low only to be filled $20-$30 higher than when it was first placed
with their Broker. With high volatility stocks (stocks with a large number of shares executing every
minute) it may take several minutes before your order will move up in the line to be executed. Also, if
you are using a Web based program to execute orders it my take several minutes to get the order processed
and moved to a Market Maker or ECN to be placed in line for execution.
Day traders like it when a lot of Market Orders are being placed because
that means the stock price will be moving steadily in one direction or the other. With direct access
software day traders, Brokers, and Market Makers have the means to take advantage of all of those Market
Orders filling all of those Limit Orders.
What’s this you say, "Brokers, have the means to take advantage of
all of those Market Orders". That’s right! Those Brokers that actively trader their own or House
accounts just love Market Orders as those orders provide constant movement in prices. Remember, those
Brokers are also using Limit Orders to Buy and Sell stock. Yep, it’s a real Bummer. They get their
commission plus get their orders filled at the same time.
Now, when is a Market Order OK to use? Typically, Market Orders can be
used if there is a low volume of shares executing for a given stock or even if there are no executions at
that time. However, if you place an order for a large number of shares your order may be broken up into
smaller lots and filled at several price levels.
Also, if a stock price is moving against you and you want to liquidate
your holdings fast, you can take the chance and place a Market Order. However, we strongly recommend that
in this case, you pick a lower or higher price, depending on the direction of the price movement, and
place a Limit Order.
A good rule of thumb though is to stay away from high volume, fast moving
stocks, especially IPO’s until you gain a lot of experience trading in the markets.
Want to learn more on how stocks are executed in the markets. Go to our
Recommended Reading at: http://www.rookiedaytrader.com/books.htm
, visit your public library or visit your local bookstore.
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