What is a limit order?
A limit order is an order to buy or sell a stock or a security at a specified price or better. This order is intended to benefit investors by giving them the best price possible and protecting them from major losses.
This order guarantees the price but does not guarantee the execution of the order.
How does a limit order works?
A limit order can be used when you are buying or selling securities. The following are descriptions of each type of limit order with examples.
a. Limit buy order
This order is used when you are buying stocks and other securities. In this order, you are telling your broker that you will only buy the stock or a security at the price you specified or better. That is, you will not pay more than what you specified.
Example of a limit buy order
Let’s assume that a stock you want to trade is currently trading at $10 per share. You feel like $10 per share is expensive. So, you place a limit buy order at $7.50 per share. This means that you want to buy this stock at $7.50 or below.
You can treat a limit buy order as the maximum amount you are willing to pay for a stock or other securities.
b. Limit sell order
A limit sell order is an order to sell a stock or a security at a specified price or better. It is like the opposite of the limit buy order. What it means is that you only want to sell a stock or other securities at a price you specified or above.
Example of a limit sell order
Let’s assume that the stock you have been holding for a while is currently trading at $12 per share and you want to exit your position.
So, you place a limit sell order to sell all or some of your shares at $14 per share. This order means that your shares will be executed at $14 per share or above.
If the price does not reach $14 per share, your order will stay open or be canceled if the specified time is over.
Benefits of Limit orders
Whether you are buying or selling equities, limit orders should be your friend. The following are some of the many benefits of limit orders.
- Your orders will be filled at the price you specified or better. In order words, you will not pay more than you are supposed to pay on your position size.
- You will be protected from major losses you could face if you used a market order
- You avoid high volatility and spread issues if the stock is trading at a low trading volume.
Disadvantages of limit orders
Although the limit orders protect you from a lot of bad things in the market, they have disadvantages of their own. The following are a few of the many disadvantages of limit orders.
- There is no guarantee that all your shares will be filled. In order words, you will get filled at the price you want, but you will only get the number of shares available at that price.
- The order can kick you out of a winning trade. For example, let say that you placed a limit sell at $8 per share. When the price reaches this price, your order will be executed. However, it is possible that the stock will continue all the way to $20 per share. For this reason, you will lose all gains above the execution price.
- Your order could never get filled. Although the limit orders guarantee the price, there are chances that your orders will never be filled. If the price does not move in the direction at which you set your order, your order will never be filled. It will stay open or be canceled if the specified time is over.
Final words
You must use limit orders on all your trades to avoid major losses due to volatility, spread, and low volume.
Is your order not filled? No problem. You were not meant to trade that stock! You would rather miss the trade than getting filled at prices you don’t want.
