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Limit order refers to that kind of an order that purchases or sells the security at the mentioned price or better, for example in case of sell limit orders it will be triggered only when it is at limit price or higher whereas for the buy limit orders it will be triggered only when it is at limit price or lower.
Limit Order Definition
A limit order is one of the order types in the share market that allows traders to sets the desired price at which they are willing to buy or sell. It gives a trader more control for the execution of security’s price than in the case where they are worried about market order during volatility. Traders specify their own price using limit order whereas in market order market choose a price. They can be modified until it is executed.
It is purposely used to get a certain better price, and thus it must be placed on the correct side of the market.
- Buy Limit Order= At or Price less than Current Market Price
- Sell Limit Order= At or Price more than Current Market Price
For example, if Mr. Bill is a trader who wishes to buy 100 stocks of Tropical Inc. but has a limit of $20 or lower. If he wishes to sell the same shares at a price $22, he will not see; the shares until the price $22 is reached or it is more than $22.
Types of Limit Order
As we can see from the above example that there are two types of Limit order.
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- Buy Limit Order – A Buy Limit Order is also known as “Limit Order to buy” is the order placed at a specified limit price or lower than it.
- Sell Limit Order – A Sell Limit Order is also known as “Limit Order to Sell” is the order placed at a specified limit price or higher than it.
Limit Order Examples
Let’s see some simple to advanced examples.
Suppose a portfolio manager wishes to buy stocks of MRF Limited but believes that current valuation is too high which is $833. He wants to buy at a specified price or less.
He instructs his traders to buy 1000 shares when it’s price fall below $806.
The traders then place an order to buy 10,00 shares with an $806 limit. They can begin buying stocks automatically when it reaches $806 and less or else the order can be canceled.
Suppose the portfolio manager wants to sell shares of Amazon and thinks that the current price of $27 is too low and is expected to go high.
He can instruct 50% of the shares at a price above $35. This is Sell Limit Order where the shares will be sold only and only when it reaches $35 and above else it will be canceled.
- They let traders enter and exit deal with precise price. By this, they can attain a certain predefined goal in trading of the security.
- It can be beneficial in a volatile market scenario. When a stock is suddenly rising or falling, and a trader is worried about getting an undesirable price from a market order.
- It can be advantageous when the trader cannot keep a regular track on his portfolio but has a specific price in mind at which they would like to execute buy or sell of any particular security. They can be placed with an expiration date.
- It is subject to the availability of security at a set price. Although it prevents negative execution of trading, it doesn’t guarantee a buy or sells action always because it will be executed only and only when the desired price is attained. In this way, traders can miss an opportunity.
- Traders have to enter a limit price correctly to ensure the accomplishment of the goal to get a specified price. It’s important to be on the upper hand of market price, otherwise, the trade will be filled at the current market price.
- As compared to market orders, brokerage fees for limit orders are higher. If the market price never reaches a high or low price as the investor specified, the order is not executed, hence it is not guaranteed. They are more technical and also not so straightforward trades, they create more work for the brokers that lead to a higher fee.
- They are not suitable for aggressive trading techniques because such order executions are important rather than price.
- While using it, the market may not touch the price. It is hard to make money in these scenarios.
- It may be difficult to find the actual price and making limit orders a suitable option in case of low volume stocks that are not listed on major exchanges.
Important Points to Note
- The risk with Limit Orders is that the current price must never fall within the limit order’s criteria as in this case, the investor’s order may fail to execute.
- At times, the target price may reach, but there could not have enough liquidity to fill the order.
- It is featured with price restriction, it may sometimes receive a partial fill or no fill.
- All stock market transactions are impacted certain points like availability of stocks, the timing of transactions, liquidity of the stock and size of the order.
- There are always present priority guidelines for limit orders.
Limit Order provides the trader to pre-determine the price at which they want to buy or sell. It is concerned with ensuring that price considerations are fulfilled before the trade is executed. It deals primarily with the price of a security. So, if the security’s price is currently resting outside of the criteria set in the limit order by the trader, the transaction does not happen. They can be beneficial in the scenarios where a stock or other asset is thinly traded, have highly volatile, or posses a wide bid-ask spread where a bid-ask spread is the difference between the highest price a buyer is willing to pay for a security in the market and the lowest price a seller is willing to accept for a security.
Placing a limit order puts a cover on the amount an investor is willing to pay. It always allows precise order entry and is appropriate to traders when it is more important to get a specific price rather than the execution of trade to get filled by the market price.
This has been a Guide to Limit Orders and its definition. Here we discuss the types of limit orders along with an example of Buy/Sell, advantages, disadvantages, and limitations. You can learn more about financing from the following articles –