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Stock prices can rise and fall quickly, sometimes fluctuating by the second. These rapid price moves can complicate the life of traders. It may be difficult to predict what price they’ll receive if they’re buying or selling a stock. This predicament is precisely what limit orders can help solve.
Limit orders let traders name a price at which they want to trade rather than simply buying or selling their shares at whatever the market price is. In other words, limit orders put traders and investors in control and allow them to determine the price that they’re willing to transact at.
How does a limit order work?
Limit orders allow traders and investors to specify a price for the stock they want to buy or sell. When buying stock, a limit order will not execute unless the stock falls below the specified price. When selling, the order won’t complete until the price climbs above the specified price.
When traders place a limit order, they can specify how long the order should stay open, such as a week or a month or “good ‘til canceled,” though the latter usually means only three or six months, though it varies by broker. The limit order will stay open until it is filled or until it expires.
For example, suppose you want to sell 10 shares of TUVWXYZ Corporation, priced at $15 per share. However, you believe the price will rise to $18 per share within the next month. You then can open a sell limit order for 10 shares at $16 lasting one month. As a result, your shares won’t be sold until the price reaches $16 per share. If that happens in the next month, the order will fill. If the price doesn’t reach that level before the order expires, your shares won’t be sold.
Limit order vs. market order
Limit orders are a popular order type, and the other major type is called a market order. While limit orders let traders specify their price, a market order executes the trade as soon as possible at the next available price – regardless of what that price is.
Thus, the price of limit orders is guaranteed but the trade execution is not. In contrast, the trade execution of a market order is guaranteed if there’s a counterparty, but the price is uncertain.
That’s the major difference between limit orders and market orders, but each has a place in an investor’s toolbox and using one or the other could save you money, depending on the exact situation. Here’s when it’s best to use each type of order and why.
Limit order vs. stop order
Traders can use both limit orders and stop orders to limit potential losses, but there are subtle differences in how limit orders and stop orders work.
With a limit order, traders specify the highest price they are willing to accept for a buy or the lowest price they are willing to accept for a sale. The order will not execute until the specified price is available. However, a stop order is a trade that executes at the market price once the stock has traded at a specified price, also known as the stop price. The stop order is a kind of conditional order that is triggered only once the condition – reaching the stop price – is met.
The goal of limit orders for traders is generally to lock in the price at which they want to trade. Conversely, stop orders can help traders avoid further loss or ride a stock’s momentum higher if a stock is moving in a given direction. For example, a trader may use a stop order for a stock that has risen and that may continue to do so. The stop order could allow the trader to buy only once the stock has “broken out” of a trading range. But the trader could use the same tactic on the downside, setting a sell stop order that triggers once the stock has fallen to a certain level.
When to consider using limit orders
While market orders can provide some instant gratification, there are times a limit order might be a good idea.
Consider using a limit order if:
- You believe the price will rise — or fall. You can use limit orders when buying and selling. If you think the stock price will rise and you are selling, you can place a sell limit order, so you don’t sell until the price rises to your specified price. If you think the price will fall and you are buying, you can place a buy limit order, so you don’t buy until it reaches your price.
- You don’t trade actively. Some traders monitor stock charts all day long and frequently place orders. If you don’t want to watch a particular stock chart until the stock reaches your desired price, a limit order might be the right choice.
- You want to trade a stock with low volume. Trading stocks with low volume can be problematic with market orders, because the bid-ask spread may be wide. If trading volume is low, a single order could change the stock’s price substantially, which may happen frequently in after-hours markets. A limit order can help you avoid paying too much on a purchase or selling for too little since it allows you to specify your price.
Limit orders allow traders to buy or sell a stock only if it reaches a specified price. While traders may use market orders to get an immediate trade execution, it can often make a lot of sense to set a limit order – even on a liquid stock – so that you know exactly the price you’re getting.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.