Limit Order

What is a Limit Order?

A limit order provides an instruction to the broker to execute a trade ticket if the price of the security being bought or sold reaches a certain level or better – the limit price. Both buy and sell orders will only be executed if the market price matches the limit price.

With limit orders, investors can control the price they get when buying or selling financial instruments. However, there are no guarantees that the order will be executed as the market price may never reach the limit price before the order expires.

Techopedia Explains the Limit Order Meaning

The difference between a limit order and a market order is that the latter is executed at the best available price, while the former is only executed if and when the market price matches the limit price. Investors can use limit orders to control the entry and exit prices of their trades more efficiently. However, the downside is that the order may never be executed.

With buy orders, the order is executed only if the price is equal to or lower than the limit price, while sell orders are executed only if the price is equal to or higher than the market price.

Limit orders may stay open for as long as the investor wants. Depending on the broker, most financial services firms offer options like day, good-til-canceled (GTC), and all-or-none (AON) orders.

How Limit Orders Work

A buy limit order prevents the investor overpays if the stock price unexpectedly increases.

For example, if an investor wants to buy shares of Tesla (TSLA) but only if the price dips below $120 per share, they could place a buy limit order for TSLA and set the limit price at $120. As long as the order remains open, if TSLA stock trades at a price of $120 or lower at any point, the order will be executed by purchasing the shares at that price or cheaper.

Meanwhile, for a sell limit order, once the stock rises to the limit price or higher, the order will be filled by selling the investor’s shares at that price or better. This protects investors from selling too low if there is a surprise drop in the stock price.

Say an investor owns shares of Tesla (TSLA), currently trading at around $140 per share. If they want to sell but only if the stock reaches $150 or higher, they could place a sell limit order for their TSLA shares and set the limit price at that level. If TSLA stock hits $150 or higher before the order expires, their shares will be automatically sold.

Investors may want to use a limit order in one of the following two scenarios:

1. They have a target buy or sell price in mind for the security based on their analysis or personal preferences.
2. They want to automate the buying or selling process without constantly monitoring the stock’s price movements.

Meanwhile, limit orders offer price protection but do come with some drawbacks compared to market orders:

• No guarantee of execution if the stock never hits the limit price.
• Potential to miss out on better prices if the stock moves past the limit price quickly.
• Risk of partial fills that could prevent some shares from being bought or sold if price volatility is high.

When to Use Limit Orders

Now that we have studied the definition of limit order, it is worth noting that there are specific instances in which this type of instruction may be the wisest alternative for traders to operate in the financial markets. Here’s a summary of the five most common ones where it makes sense to use limit orders.

Types of Limit Orders

In addition to customized expiration times and full/partial fill requirements, limit orders can be combined with other advanced order types, like stop orders, to create more sophisticated instructions that fit the trader’s system and strategy.

Limit Orders vs. Market Orders

This is a summary of the key differences between limit orders and market orders:

A market order is generally a better choice for liquid stocks with tight bid-ask spreads when executing the trade immediately takes priority over getting a specific price or when price volatility is low in the near term.

However, for less liquid stocks or during periods of high volatility, limit orders give investors more control by allowing them to set a price threshold that the system will respect when executing the instruction. This price protection comes at the cost of having no guarantees that the trade will be ultimately executed.

Market orders guarantee execution at whatever the current market price is at the time. However, limit orders only execute if the price moves to the investor’s specified limit price or better before expiring.

Limit Orders vs. Stop Orders

Stop orders are another type of conditional order used to automate trades, but they work in the opposite way as limit orders:

With a stop order, once the stop price is reached, the system automatically creates and executes a market order to buy or sell the instrument at whatever the current market price is at that point.

For example, an investor could set a stop-sell order on a stock they own at $40 – the stop price. If the stock drops to $40, a market sell order would be triggered at that point to exit the position. The risk in this case is that the market order could be filled at a price lower than $40 if price volatility is high at the time.

Stop orders are generally used as exit signals and risk management tools, while limit orders are used to automate entries and exit at precise price targets.

Limit Order Examples

Example 1

Imagine that the stock ABC is currently trading at $25 per share. An investor wants to buy the dip, but only if the stock falls to $15 or lower, as this would provide a good opportunity based on their analysis. They place a buy limit order for 100 shares of ABC with a limit price of $15.

If ABC’s price drops down to $15 or lower at any point before the order expires, the order will be automatically executed by purchasing 100 shares of ABC. However, if ABC stays above $15, the limit order will not be filled.

Example 2

On the sell side, let’s say that the same investor already owns 200 shares of ABC from a previous purchase, with an average cost basis of $22 per share. However, he wants to sell if the stock rallies up to $30 per share.

To automate that exit, the investor places a sell limit order for 200 shares of ABC with a $30 limit price. If ABC stock reaches $30 or higher before the order expires, the order will be executed by selling all 200 shares at that price or better.

However, if ABC fails to hit $30 during the order’s maximum time period, the sell limit order will simply expire unexecuted, leaving the investor still holding the shares.

Partial Fills on Limit Orders

Limit orders may not be filled entirely if the system is unable to find buyers and sellers who are willing to match the limit price. When just a fraction of a trade ticket is executed, that is known as a partial fill.

Let’s say an investor wants to buy 1,000 shares of ABC stock, as discussed in the earlier example, but another party is offering only 500 shares at the limit price or better. Unless the trade ticket is set up to all-or-none, the system will buy the 500 shares and leave the remaining 500 shares separately in an open order that has yet to be filled.

Partial fills may only be avoided with AON orders, as they require that the entire quantity be bought or sold at once. The downside of this type of order is that it may never be filled unless the market price eventually matches the limit price.

Limit Order Pros and Cons

As with all types of trade orders, limit orders have advantages and disadvantages that traders must understand and consider before using them. Here’s a summary of their pros and cons.

By understanding and proactively managing these risks, investors can use limit orders to their advantage while avoiding nasty surprises like human errors or changing market conditions.

The Bottom Line

Limit orders are an essential tool for traders and investors who want to exercise more control over the prices they pay or get when buying or selling stocks and other securities.

By setting specific limit prices, investors can automate trade execution once their preferred price levels are reached without to need to constantly monitor positions or market prices.

However, limit orders do not guarantee fills and come with the risk of missing further price movements or better entry/exit opportunities if the limit price is too strict.

Combined with other advanced order types and duration settings, limit orders can be quite flexible and powerful. However, that flexibility also adds complexity that requires prudent risk management by investors.

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