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What Is a Limit Order?


September 2022

One way that you can manage risk while tradingis by using what is referred to as a “limit order.” These orders specify the most you are willing to buy or sell a security at. Depending on the situation, you may wish to pay an exact amount, or a better price, for your purchase. It should be noted that if the price isn’t hit, including being “jumped over”, the order may or may not be triggered, depending on whether it is used as protection or simply to enter the market.

Limit orders are instructions given to the broker on behalf of the trader to execute a trade under certain circumstances. A limit order will guarantee that the trader will only buy or sell at a specified price or better. 

How Do Limit Orders Work? 

A limit order is an order that has a prespecified price to buy or sell a security. For example, if a trader is looking to purchase stock with a limit of $10.50, they will only buy the stock at the price of $10.50 or lower. If the trader were looking to sell those same shares with a limit of $12.50, the trader would not fire off a sell order of any shares until the price is $12.50 or higher. 

By using a limit order, the trader is guaranteed to pay the specified pricebut is not necessarily assured that the order will be filled. A limit order will give the trader more control over the execution price of a trade, especially if they are worried about using a market order during periods of heightened volatility. 

Limit Order Example 

A trader wishes to buy American Airlines (AA) but believes the price of $21.48 is high. The methodology they believe in says that the cost of AA should be lower but that it should continue to appreciate over time. Because of the trader’s methodology, they feel much more comfortable buying AA at $20.50. 

The trader puts in a buy limit order to buy AA at $20.50 and waits to see if the market drops to that level. In one scenario, the trader sees the stock price fall to the $22.50 level, and the order is triggered. Perhaps they even get a bit lucky, and their order gets partially filed just below $22.49. (The order simply states, “I want to buy x amount of AA, and I will not pay more than $20.50 for it.” The trader certainly would not have an issue paying a little less if they can.) 

In another scenario, the price of American Airlines doesn’t fall enough to fulfill the trading order. This means that the trader simply will not be buying it. The conditions weren’t met, so the order wasn’t triggered. 

How Long Do Limit Orders Last? 

Limit orders can last for as long as you choose. There is no ‘rule’ as to how they have to be placed, but depending on the situation, there are a few general guidelines that traders and platforms tend to stick to. 

What’s a Limit Price in Stocks? 

The limit price is the price that the trader sets. It’s the price that a limit order will be executed at assuming that the asset reaches that particular level. Think of it as the price an investor is willing to pay for a stock or sell it for. 

Limit Order vs. Market Order 

While limit and market orders are the two most common types of orders, they are vastly different in their execution. The market order tells the broker that the trader wants to buy or sell an asset at the best price. Market orders are executed immediately, regardless of the available price. They are vulnerable to slippage when the price moves quickly enough to make your order execute far from the original price. This is especially true in fast-moving markets. 

For example, you decide to place a buy order for Ethereum at $1325. You place a market order to do so, but the market price is moving quickly. The cost of Ethereum continues to rise rapidly, and you get a price above $1325. Depending on the market conditions, it can be a substantial difference. 

With the same scenario, the trader could have put in a buy limit order to buy Ethereum at $1325. The price moved so fast that they didn’t get their order filled. The limit order did its job – it kept the trader from paying more than they wanted. Some platforms allow for “variation” of the order. Perhaps you are okay with paying up to $5 extra for this order. In that case, your order could have been filled at, say, $1327.34 as it was within the tolerance of the order.

Limit Orders vs. Stop Orders 

A stop order is a bit different than a limit order and can be a stop-loss order or a stop-limit order. Both types of stop orders are orders that are used to protect from seeing losses get out of hand. They instruct the broker to get out of the market if the price of an asset moves against you. A stop-loss order will specify a certain level of price that will trigger the sale of an asset or, in the case of a short position, the buying back of that asset. This is to protect the account from experiencing worse losses than necessary. This is essentially where the trader tells the broker, “Get me out at the best price available.” 

The stop-limit order works similarly, but only when the asset price hits a certain amount. Sometimes, the broker will allow you two levels to execute within, meaning there is some tolerance for slippage or the move against you getting worse to ensure you get out of a losing trade. However, if the market is moving too fast and the broker can’t follow the tolerance, you will not have the order executed. This can be a dangerous thing in the wrong environment.

Why Use a Limit Order? 

Below are some of the most common reasons someone might want to use a limit order: 

What Are the Downsides to a Limit Order? 

Although there are quite a few advantages to using a limit order, there are also some downsides. Traders should be aware of a few things: 

How to Place a Limit Order 

Typically, it is  done by the same dialog box that you would use to place any trade on your platform. If you are ready to place a trade, you typically need to change a dialog box from “market order” to “pending order.” After that, you choose “limit order.” At this point, you need to place the appropriate price at which you are willing to execute your position. Any appropriate stop-loss order should also be mentioned in this transaction as well, and the broker will then simply wait to see whether or not the proper conditions get reached.

Conclusion 

Limit orders are a great way to ensure you do not get filled at a less advantageous price. After all, the market can be very volatile at times, and using buy limit orders and sell limit orders might be the best way to mitigate some of the issues you can run into. Sometimes the market gets into a kind of runaway mode, and the worst thing you can do is jump into the market with a “market order” and get filled at a horrible price. 

However, they are not necessarily helpful when it comes to protecting your account because if you have a limit order being used as a stop order, the price can jump over your trigger price, perhaps leaving you exposed. In that situation, you are looking at the need for a stop-loss order. Jumping into a market with a “market order” is a very amateurish way of trading.

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