The Probability of Limit-Order Execution

Market orders and limit orders are the two main types of orders investors use to buy or sell U.S. equities. In choosing between the types, investors must weigh the price improvement associated with a limit order against the probability that the order will not be executed. In the study reported here, we examined the probability of limit-order execution and the expected benefit to limit orders for a sample of stocks traded on the NYSE. Results indicate that the longer a limit order is outstanding, the less likely it is to be executed. The probability of execution is higher for sell orders than for buy orders, lower when the limit price is farther away from the prevailing quote, lower for large trades, higher when spreads are wide, and higher in periods of high price volatility. Order-placement strategy and trade execution are important issues in equity investing. The two main types of orders that investors use to buy or sell U.S. equities are market orders and limit orders. Effective trading with limit orders requires the investor to judge the costs and benefits of using limit orders versus market orders. The goal of our research was to estimate the benefit associated with limit orders-a benefit that may be offset by the opportunity cost of immediacy provided by market orders and the probability that the limit order will not be executed. This assessment of execution probability is likely to be influenced by a number of factors in the market, including the desired price, the prices at which other investors are willing to buy or sell the security, and the size of the intended trade.We used the TORQ (trades, orders, revisions, and quotes) data for NYSE securities to address execution probability. These data contain detailed order, transaction, and quote information on 144 NYSE stocks for the period November 1990 through January 1991. Because of the large number of observations, we randomly selected 10 stocks to study. We examined the waiting time until order execution by using duration analysis, a statistical technique that is appropriate when examining the passage of time until an event occurs.We found that the longer a limit order is outstanding, the less likely it is to be executed. The probability of execution is higher for sell orders than for buy orders, lower when the limit price is farther away from the prevailing quote, lower for large trades, higher when spreads are wide, and higher in periods of great price volatility. We also found that the average expected price improvement from a limit order over a market order is greater at the beginning of the trading day, in periods of high price volatility, in the presence of wide bid–ask spreads, and for large orders.Our results suggest that investors seeking the best possible order-placement approach should carefully consider the probability of limit-order execution. More formal attempts to quantify this probability might be useful, especially for large orders. Investors might also wish to attempt to quantify the opportunity costs of immediate trade execution, which they forgo when they place a limit order instead of a market order.