What is a Limit Order?
Limit orders are a nifty way to gain more control over your assets. IThis guide explores how limit orders work and their various forms.
Originally published on Zinvest: zvstus.com/blog/what-is-a-limit-order
Limit Order Defined:
An investor can set a limit order to buy or sell their securities at a specific price. This method provides the investor with more control over how they handle their assets.
Introduction
Investors have the opportunity to specify their types of orders when trading assets — these are known as trade orders.
While there are multiple types of trade orders, a limit order is presented as one of the most common, along with market orders and stop orders.
When an investor begins to trade with limit orders, they can establish a buy limit or sell limit with a limit price, allowing for more control over how their asset prices are bought or sold.
Understanding Limit Orders
A limit order can be a favorable option to investors as the specific restrictions provide advantages that other types of orders do not.
For investors placing orders at limit, they can set a clear minimum price or maximum price in which they want to buy or sell their shares, offering opportunities in profiting and reducing risk in losses.
However, unlike a market order, where trades are executed immediately upon filling an order at the current offer price, there is no guarantee of execution with a limit order.
Once a limit order is filled, it can be executed, but only if the price of the stock reaches the specified limit price or better. If the stock’s market price never reaches the limit price, the order will not execute.
Additionally, limit orders work on a first-come, first-served basis, so even if the limit price is reached, the order may not be filled depending on the availability of a company’s shares.
How Do Limit Orders Work?
A limit order is most effective when an investor believes they can purchase shares at prices lower than the current market price (using a buy limit order) or sell when prices are higher than the current market price (using a sell limit order).
Buy Limit Orders
For investors, a buy limit order guarantees assets will be purchased at the specified price or less. If an investor believes that the price of a share was to decline, buy limit orders are an advantageous tool.
For example, you believe Company A’s shares are overvalued and currently sells at $20 a share.
Before investing, you could set a buy limit order to buy the company’s shares at $15 or less.
If your presumption is true and share prices decline to the buy limit order, your broker will purchase those shares at $15 or less.
It’s important to note, as mentioned previously, that establishing a buy limit order does not mean that an investor is guaranteed those shares at the lower price — the limit order will only trigger once share prices decrease to the limit price.
If share prices never decrease and instead gradually rise, the investor will miss out on the opportunity to buy in when the stock price is lower.
Sell Limit Orders
Alternatively, investors can set a sell limit order to trade shares at a specified price or higher in the stock market.
Let’s say you purchased shares from Company A, and its market price is at $20 per share.
Although you want to sell the shares now, you feel like the prices are too low. You can then position a sell limit order to trade at $25 per share. Once stock prices increase to that limit price or higher, then the sell limit order will be triggered and possibly executed.
Other Types of Trade Orders
Market Order
A market order is the most common type of stock trade; this trade order lets investors buy or sell shares at the prevailing market price.
Market orders are best utilized when an investor is considering executing trades immediately and wants a fill on their order.
Stop Order
A stop order comes with its distinctions, and it’s based on prices unavailable to the market at the time of placing. There are variations of a stop order, such as buy-stop, sell-stop, stop-loss, and stop-limit.
Once a stop price is reached, the stop order is triggered. The stop order then converts into a traditional market order.
A buy-stop order is placed with a stop price higher than the current market. Meanwhile, a sell-stop order is placed with a stop price lower than the current market.
Simply put, stop orders are placed to prevent losses if a shareholder’s position becomes unfavorable. A stop-loss triggers a market sell order if the stock price falls below a specified threshold. In a volatile market, however, this may be a bit riskier. With constant fluctuations, prices may rise and fall greatly, triggering a stop-loss sooner than expected.
A stop-limit order is a blend of a stop and limit order. Once the conditions for a stop-limit order are satisfied, rather than converting into a market order and trading immediately, a new limit order is placed.
Conclusion
While there are numerous types of trade orders available to investors, limit orders provide a useful method in profiting and reducing risks.
In contrast to market orders, which execute immediately off a current stock price, limit orders allow investors to set a specific price to buy or sell shares once triggered.
Because of its distinct nature, however, not all limit orders will execute. If the established limit price is not reached, the trade order will never trigger, causing a potential loss in opportunity.
Despite this, limit orders offer advantages to both novice and experienced traders, as they are designed to benefit the investor with reduced risks.
