Market or limit orders?

Abstract

In this paper we investigate the problem of optimal order placement of an asset listed on an exchange using both market and limit orders in a simple model of market dynamics. We seek to understand under which settings it is optimal to place limit or market orders. Limit orders typically lower transaction costs but increase the risk of incomplete order execution, whereas market orders typically have higher transaction costs but are guaranteed to be executed. Rather than considering order book dynamics to determine if a limit order is executed we rely on price dynamics for this. We look at implementation shortfall in this setup with market impact of trading and propose a dynamic program to find the optimal placement of both market and limit orders for risk-neutral and risk-averse traders. With this we find a bound on the expected cost of trading and show that a trader who behaves optimally should always expect to pay less to trade less. We then solve the dynamic program numerically and examine optimal order placement strategies. We find that the decision between market and limit orders is sensitive to price volatility, risk aversion, and trading costs.

Keywords:

• Order placement
• Market order
• Limit order
• Implementation shortfall
• Dynamic programming

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

Daniel Mitchell http://orcid.org/0000-0002-8361-8863

Jingnan Chen http://orcid.org/0000-0003-0877-2278

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1 Fees and rebates are typically exchange specific. For example, BATS posts their fee schedule at http://www.bats.com/us/equities/membership/fee_schedule/bzx/

Additional information

Funding

This research was partially supported by the National Natural Science Foundation of China (NSFC) under grant 11801023 and Beihang University under project ZG216S1983.