Investor's Guide to placing stock orders (part 2)
Market vs. Limit Orders: Rules of Thumb

To figure out whether you should place a limit order or a market order, you need to think about three things:

• The price at which your order will be filled if you place a market order
• The chances that a limit order at a specified limit price will be filled
• What will happen to the price of the stock if your limit order does not get filled

The first of these, the price at which a market order would be filled, is pretty easy to estimate from the current quote. As long as your order size is smaller than the amount of shares quoted, then you are pretty much assured of getting the quote or better. Even if your order is somewhat larger than the current quote, you may still be able to fill your order quickly at the quoted price. (Most individuals will not be trading large block orders, which isn't covered in this article.)

Calculating the probability that a limit order will be filled is much more difficult. Here are some general guidelines for deciding whether to use a limit or market order when buying and selling stocks:

NYSE or Amex
First, ask yourself how anxious you are to make this particular trade. In general, if you think that the stock is about to make a major move, then you are better off getting the immediate execution of a market order rather than running the risk that your order may not be filled and the stock may run away from you. If you can be patient, then your patience may allow you to get a better price for your trade through placing a limit order.

Second, find out what the bid and offer quotes are when you are about to place a stock order. Also, look at the recent trading volume to get a sense of how active the stock is. A limit order is more likely to be filled if the stock is actively traded.

If the spread between the bid and ask price is only one tick  (1/8 for stocks over $5.00 per share) and there are a substantial number of shares (say, more than 1,000 shares) quoted at the bid, then you should use a market order, since your savings from a limit order is likely to be small, and there is a good chance that your order will not be filled.

If the spread between the bid and the offer is more than one tick, consider placing a limit order with a limit price between the bid and the ask prices. Sometimes it is worthwhile to place a limit buy order at the bid price, but only if there are not many shares quoted at the bid.

If you really want to buy the stock, do not place a limit order with a limit price below the current bid price, since the probability that the order will be filled is so low that it is rarely worthwhile. Limit orders are best viewed as a way to bypass the market makers and save on transactions costs, not as a way to buy stock at windfall prices.

NASDAQ
Since the NASDAQ market mechanism is so different from the exchange mechanism, a different strategy is necessary. Many retail brokers will say that you must buy at the ask and sell at the bid for NASDAQ stocks. However, there are ways around this, but they involve more work for the brokers, who may resist taking the extra steps to help you. You may place a limit order for a NASDAQ stock in between the bid and offer quotes, and then insist that your brokerage firm advertise your order as widely as possible via the SelectNet system, the NASDAQ service that facilitates communication regarding orders for NASDAQ stocks. This will alert the other market makers and retail brokerage firms that your order exists, which may solicit a response.

For orders less than 1,000 shares, insist that your limit order be placed on the SOES (Small Order Execution System) Limit Order File so that it can be widely disseminated. This will also make others aware that your order exists, and may help your broker find the other side of the market to fill your order. Then again, it may not, if no one is willing to take the other side of your trade. Since some NASDAQ firms are very small and trade infrequently, you may have little choice but to pay the market maker's prices if you want to trade quickly.