Whenever you buy or sell penny stocks, you basically choose between two types of orders – market order and limit order.
Using the wrong order type when trading penny stocks could turn out to be an expensive mistake. This is because penny stocks are usually thinly traded and more volatile when compared to regular stocks.
So, which is the order type that is best suited for penny stocks? Before knowing the answer to that, it is important to understand the difference between the two order types.
What is a Market Order?
In a market order, you ask your broker to buy or sell the penny stocks at the next best market price. The advantage of market orders is that your order would be quickly filled. However, the disadvantage that the order may not be fulfilled at the price you intended, especially if the trading volume is thin. Due to this risk, market orders usually have high margin requirements.
What is a Limit Order?
In the case of a limit order, you basically ask your penny stock broker to only buy at or below a certain price. This means that your order to buy or sell the penny stocks may never be executed at a price that is greater than your limit price. A limit order thus makes it possible for you to have more control of the price at which you trade your penny stocks. Using limit orders, you can quickly buy or sell when the penny stock falls to a certain price level.
Remember that market orders are the default for most brokers. This means that until you specifically choose a limit order, you will be making a market order.
Which Order Is Best For Penny Stocks?
Now that you have understood the difference between market orders and limit orders, let’s see which order is best for penny stocks, and why.
Limit orders are best suited for trading penny stocks. This is because market orders have a lot of drawbacks. They are,
#1 The number of Penny Stocks available at the asking price may be low in the case of a market order. Assume that you are trying to buy 200 shares of a penny stock. Assume that your asking price is $0.70 (70 ¢). However, if there are only 100 shares of the penny stock available at that price, then, you may have to pay $0.80 (80 ¢), $0.95 (95 ¢) or even more, for the other 100 shares.
#2 Lower trading volume can push prices when using market orders. Many penny stocks have low volumes of trading. So, when a significant market order is placed for that penny stock, it could cause the prices to surge or decline.
#3 Market Orders Can Cause Wide Spread between Bid and Ask Prices. Even if the last price on which the penny stock was traded was 50 ¢, you may end up paying the lowest available asking price when using market orders. This price could be something much higher.
On the other hand, limit orders are best for penny stocks because
- They can be used for buying or selling the shares of penny stocks without moving the market
- They can be used for buying shares at the intended price or lesser, or for selling shares at the intended price or more.
- Limit orders are good for buying penny stocks that have low liquidity.