Question: I placed an order with my brokerage but ended up buying the stock at a slightly higher price than I was expecting. Doesn't a stock quote tell you how much you can buy a stock for at that moment?
Answer: The stock and ETF quotes you see online do represent the price at which a given security is trading at that moment, but there are a few possible explanations as to why the price you ended up paying was different:
When quotes go bad
First, there's a chance that what you were looking at online was a "stale quote," which is market slang for a price quote that is old and therefore no longer valid. Most brokerage websites provide quotes to their customers in real-time so that investors can see how the market is moving as it happens. However, many free financial and news websites, including Morningstar.ca, provide quotes that are delayed by up to 20 minutes. So if you see a price quote somewhere for a stock or ETF and it spurs you to action, first check to ensure it's a real-time quote before doing anything. Otherwise you could end up buying higher or selling lower than you had intended. Look for language that indicates that quotes are delayed or for a time stamp that indicates when the quote came in. On Morningstar.ca the timestamp is right below the quote price.
Trading less liquid securities could leave you soaked
For highly liquid stocks and ETFs (meaning those that are heavily traded throughout the day), your purchase or sale price is likely to be within a penny or two of the quoted price when using a "market order," which tells the brokerage to make your trade as soon as possible. That's because usually enough shares are being traded at any given moment to fill orders at or close to the current quoted price.
Thanks to computerized trading, market orders for most securities traded on the Toronto Stock Exchange, New York Stock Exchange and NASDAQ are filled within one second. So clicking on your computer mouse to place a trade is often a near-instantaneous process.
However, things can get trickier when dealing with less-liquid securities, such as stocks and ETFs that trade only a few hundred shares a day. In these cases the bid-ask spread -- the gap between the price at which sellers are willing to sell the security and the price buyers are willing to pay -- is often wider. That means if you place a market order for one of these thinly traded securities, you could end up paying quite a bit more per share than the current quoted price. This is particularly problematic with many of the newer ETFs that have low trading volumes.
To illustrate, let's say an investor places a market order to buy 100 shares of an ETF that last traded at $10 per share and with a current bid price of $9.50 and a current ask price of $10.50. By placing a market order, the investor ends up buying 100 shares at the ask price of $10.50, thus paying $1,050 for shares he thought would cost only $1,000. (For more on best practices in ETF trading, watch this video from our U.S. colleagues.)
Why limit orders can be your friend
To avoid paying more than you intend for a stock or ETF, or selling at a lower price than you intend, one option is to use limit orders, which set clear parameters regarding the price at which you are willing to buy or sell a security. Whereas a market order is filled immediately at whatever price the security is trading at, a limit order can be filled only at or below the limit price if buying shares, or at or above if selling shares. So if an investor places a limit order to buy 20 shares at $50 per share, that order can only be filled at a price of $50 or lower.
One downside to limit orders is that the investor may miss his or her window of opportunity to purchase or sell shares of a security at close to his or her target price. Using the example above, if only 10 shares were available at $50 or below, then only half the buy order would be filled, whereas with a market order the full 20 shares would be purchased regardless of the price at which the security was trading. Also, some brokerages charge a separate commission for each step in filling a limit order. So if only 10 shares were available for purchase at $50 and the price then went up only to later fall back to $50 to allow for purchase of the remaining 10 shares, the investor might have to pay commission twice.
Even so, it's a good idea to use limit orders rather than market orders in most cases because of the greater control they offer. However, don't use market orders when the market is closed because news that breaks between that time and the opening of the next trading session -- such as a company's earnings announcement -- could cause a stock or ETF to trade sharply higher or lower, meaning investors would pay far more or sell for far less than they had intended.
Have a personal finance question you'd like answered? Send it to AskTheExpert@morningstar.com.
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