Market vs. Limit Orders With ETFs: Use Trading Orders to Your Advantage
Choosing a market or a limit order when you trade ETFs depends on whether you feel the need for speed of execution or control of the price. Find out why professional traders tend to use one more than the other.
When trading stocks, bonds and ETFs, you have a variety of order types at your disposal. Each order type serves a distinct purpose and has considerations that can result in different outcomes for your clients.
While market orders tend to be the default order type for stocks and bonds, limit orders may give you the upper hand when trading ETFs given their unique features.
Choosing a market or limit order depends on several factors, including your trading goals, the specific fund being traded and current market conditions. Here are some tips to help you trade ETFs more strategically.
Market Orders: Executing Quickly at the Best Available Price
When you need quick execution and fluctuating prices are not an issue, market orders will get the job done. The market order simply tells your broker to buy or sell a security at the current market price for immediate execution. The broker typically executes promptly at the best available price when the order is placed. The best available price to complete the size of your order could be way beyond the price that is currently showing on screen.
But what happens on days market conditions change quickly on unexpected news—when the asset prices of even the larger-volume ETFs can fall out of line? When volatility strikes, the price you saw when you placed a market order and the price you actually paid upon execution could be vastly different.
Market orders are always vulnerable to changing market conditions. Consider the following example that shows trading 1,000 shares of ABC ETF in a relatively stable versus a more volatile market environment.
How a Market Order Works
1,000 Shares of ABC ETF, Current Ask Price $50 Per Share
Stable Market | Volatile Market |
|---|---|
The trade executes at the best available market price at the time. In this case, the price is $50 per share. | The trade executes at the best available market price at the time for the size of the order. In this case, the prices moves, and the trade is executed at $51.50 per share. The order still gets done but now at a higher price. |
Total Cost: $50,000 | Total Cost: $51,500 |
Did you or your client expect to pay at most $50,000? In situations where you want to minimize the impact of the trade price versus the price initially seen on the screen, a limit order may be a better option.
Limit Orders: Controlling the Execution Price
A limit order lets you set the purchase or sell price for a security. The trade is executed only if the market price reaches or is better than the set limit price.
Because a limit order puts price before execution, you may have to wait longer for a trade to execute, particularly if quotes rapidly change throughout a trading day—but it’s also cost protection if the share price suddenly moves.
How a Limit Order Works
Purchase of 1,000 Shares of ABC ETF, Current Ask Price $50 Per Share
Stable Market | Volatile Market |
|---|---|
The trade executes only if the ask price is $50 or lower. In this case, the price is $50 per share. | The trade executes only if the ask price is $50 or lower. In this case, the price moves to $50.50 per share. The order does not execute until the price returns to $50 or lower. |
Total Cost: $50,000 | Total Cost: $50,000 or lower |
In these examples, execution of the limit order occurs only if the ask price is $50 or lower regardless of current market conditions. If you entered a day-limit order, the order automatically expires at the end of the day. A good-'til canceled limit order is an order to buy or sell a stock that lasts until the order is completed or canceled. Brokerage firms may limit the time investors can leave a GTC order open, which may vary from broker to broker.
A savvy move with limit orders for ETFs is to set your price a penny or two above the best offer being shown if buying or below the best bid if selling. This increases the likelihood that the order is fulfilled. If there is room for price improvement, the trade executes at the improved price.
How Limit Orders Can Expand Your ETF Trading Options
Limit orders are appropriate whenever you trade ETFs, from large to small trades. ETFs’ multiple layers of liquidity let you trade ETFs in amounts that can far exceed an ETF’s average daily volume without significantly affecting the ETF’s price when using a limit price.
You can fully access liquidity by providing a limit order to your broker to buy or sell ETF shares at a price beyond the on-screen volume. For large trades, you should always reach out to your broker’s ETF block desk.
Limit orders also expand the universe available to you to fine-tune exposures and meet clients’ needs. Currently, roughly 10% of ETFs on the market account for 90% of trading volume in ETFs.* But there’s no reason to overlook a lower-volume ETF with a wider spread than a penny if you believe it’s a better fit for the overall portfolio allocation.
Market vs. Limit Order Key Considerations
Trade execution priority: Market orders prioritize immediate execution, while limit orders prioritize price control. Market orders are good when speed is paramount for smaller trades and price is not an issue.
Volatility and liquidity: When the market is highly volatile, market orders may lead to significant price slippage, in which the execution price deviates substantially from the expected price. Limit orders help mitigate that risk by allowing you to set specific price thresholds.
Time sensitivity: Market orders typically are executed faster, making them suitable for time-sensitive situations. The investor will pay whatever price at which the trader fills the order. Trades may go off at prices significantly beyond the price shown on screen. Limit orders, on the other hand, may take a few minutes to execute depending on the specified limit price that is set and therefore require more patience. Furthermore, you may need to adjust the limit order price based on the volatility during the time the order is placed.
Risk tolerance: Market orders carry a higher risk of price fluctuations, while limit orders provide greater control over the execution price. Risk-averse investors may opt for limit orders to minimize potential adverse price movements.
ETF Trading: Common Order Types Used To Trade ETFs
Below are common order types with guidance related to ETF block trades as well as contacts to assist you in executing these types of trades:
Order Types | Description | Price Control? | Guaranteed Execution? | Suitable for Block Trades? |
|---|---|---|---|---|
Market | Buy/sell executed immediately. | No | Yes | No |
Not recommended for ETF block trades or even smaller ETF trades, given no price control. Guaranteed execution and speed of execution are the main benefits of market orders.
Limit | Buy/sell executed at predetermined price. | Yes | No | Yes |
Recommended for both block trades and smaller ETF trades, given full price control. A buy order will only go off at the trigger price or lower, and a sell order will only go off at the trigger price or higher.
Held | Buy/sell executed immediately. | No | Yes | No |
A held order is the same as a market order and is not recommended for ETF trades.
Market not held** | Order goes to a floor broker or an institutional trade desk that has both time and price discretion for execution. This usually involves getting a block desk involved. | Partial | Yes | Yes |
Recommended for large ETF trades, as the broker assesses the market to achieve efficient execution and generally requests quotes from more than one ETF liquidity provider to execute at the best price.
Limit not held** | Order goes to a floor broker or block desk that has time and price discretion for execution, with a predefined lower limit on sells and an upper limit on buys. | Partial | No | Yes |
Similar to market not-held orders with added price control from the limit order price protection. Also recommended for large ETF trades, with the slight risk of not being executed if the only offers from the liquidity providers are outside of the limits given to the floor broker.
Stop | Predetermined price set. Once the market is at the set price or breaks through, it becomes a market order. | Partial | No | No |
Not recommended for ETF trades because the order becomes a market order once the trigger price is met, putting you at risk of market moves.
Stop limit | Predetermined price set. Once the market is at the set price or breaks through, it becomes a limit order. | Yes | No | Yes |
Recommended for large ETF trades, as it becomes a limit order after the trigger price is met, providing full price control.
**Most advisor platforms have institutional desk available to assist in trading securities.
Why Experienced Traders Use Limit Orders More Than Market Orders
While some investors are more comfortable with price uncertainty than others, a limit order puts price control in your hands.
If you want to protect the price for your ETF trade, use a limit order—even if the ETF is highly liquid. Yes, submitting a limit order may take a few seconds longer than a market order, but you won’t worry about the execution price. As I see it, a limit order has your back if market conditions suddenly change.
Develop a relationship with your custodian’s institutional trading desk. Here are ways the traders can help you efficiently trade ETFs:
- Talk through specific size minimums or requirements before sending the trade.
- Identify the best way to submit the trade.
- Discuss technology requirements for submitting trades.
Note: Some desks charge a fee to place a trade.
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Source: Bloomberg, American Century Investments 08/31/2023
Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.