When you trade in the financial markets, the price at which you place your order matters significantly. To improve the chances of an order being executed, it is often advisable to place it using the at-the-market (ATM) price. An at-the-market order or at-the-market price can be beneficial or risky, depending on the prevailing conditions and your risk tolerance levels.
In this article, we explore the meaning of at-the-market prices, why they are significant and how they can be advantageous or risky.
What is the meaning of an at-the-market trade
An at-the-market order is a trade that is initiated at the current bid price or ask price prevailing in the market. It applies to both buy and sell orders in the equity, derivatives, commodity and currency markets. By placing an at-the-market order, you are essentially requesting your stockbroker to execute the trade at the best price available in the market at the time the order is executed.
For example, say that the current bid price of a stock is Rs. 500 and the current ask price of the same stock is Rs. 502. Since the bid-ask spread is quite narrow, the prices may fluctuate quickly, leading to sudden changes in the market. To ensure that, you do not miss a potential opportunity to profit and to execute your trade at the best possible price, you can place an at-the-market order.
How does an at-the-market trade work
A market order is executed using the at-the-market price — which is the best available bid price or ask price as the case may be. When you submit an at-the-market order to your broker, you must specify the quantity of the stocks or securities you want to buy or sell. However, since the execution happens using the at-the-market price, you need not specify any price limit at the time of placing the order.
Once the order request is placed, the broker matches your order with another one of the opposite type. This means that your buy order will be matched with a sell order (or vice versa). Once matched, the order is executed at the best available price. So, if you are buying, your order will be executed at the lowest ask price currently available in the market, and if you are selling, your order will be executed at the highest bid price in the market.
If the stock or security is highly liquid, your at-the-market order will be executed immediately and in full. However, if the stock has some liquidity issues, you may not be able to find enough buyers (or sellers) for the entire quantity of stocks you want to trade. So, the order may be executed in parts, at two or more different at-the-market prices.
For example, say you place an at-the-market order to buy 1,000 shares of a company at the prevailing price. Now, say the ask prices for the stock are as follows:
- 700 shares at Rs. 400
- 200 shares at Rs. 401
- 300 shares at Rs. 402
In this case, you will be able to buy 700 shares at Rs. 400, the next 200 shares at Rs. 401 and the remaining 100 shares at Rs. 402.
When to use at-the-market trading
Using at-the-market prices is best suited for certain market conditions and trading goals. Here are some scenarios when it may be better to choose at-the-market orders than limit orders, where you request the order to be executed at a specific price instead of the prevailing price.
- Immediate execution: Using at-the-market prices can be ideal if you want to buy or sell a stock or security immediately. Since these orders happen at the best prevailing price, the execution is almost immediate as long as the quantity requested is available. This is useful if you prioritise speed.
- Trading in liquid markets: In highly liquid markets, the bid and ask prices are constantly extremely close. The gap further closes if the trading volume is increasing. So, if you opt for at-the-market prices, the chances of your order being executed at a favourable price are high.
- Execution over price: If your priority is order execution rather than order price, at-the-market orders may be the most suitable option for you. Since these orders focus on executing the order at the prevailing price, you can rest assured that your order will be executed as long as the required quantity is available in the market.
- Full order completion: At-the-market orders also have a greater chance of being executed fully rather than partially. This is not the case with limit orders, where a trade may only be partially executed if the required price is not available for the required quantity of stocks or securities.
Advantages of using at-the-market prices
Now that you know when to use at-the-market prices for your orders, let us discuss the benefits of such orders. Here is why at-the-market orders can be useful.
- There is little to no delay in the order execution.
- The likelihood of complete order fulfilment is high.
- You do not need to analyse what the right price may be.
- It is particularly useful in volatile markets.
- It ensures you get the best possible price in markets with tight bid-ask spreads.
Limitations of using at-the-market prices
Despite their many advantages, at-the-market orders also have some limitations. You need to be aware of the following downsides of using at-the-market prices for your orders.
- You do not have any control over the price of the trade.
- There is a high potential for slippage in the market, where you expect one price but your trade is executed at another.
- It may result in higher transaction costs due to slippage.
Conclusion
The bottom line is that an at-the-market trade can be highly beneficial if you rely on it in the right market conditions. However, you must also keep the limitations of at-the-market orders in mind before you initiate a position in the market using the prevailing prices.
Additionally, to limit the downside risk, ensure that you set stop-loss limits as well. This will cap the maximum loss that you may have to endure from any trade if the market moves unfavourably.
