A Limit Order is a type of order placed with a brokerage to buy or sell a security at a specific price or better. Unlike a market order, which executes immediately at the current market price, a limit order sets the maximum or minimum price at which you are willing to buy or sell the security.
Key Characteristics of a Limit Order:
- Buy Limit Order:
- Purpose: A buy limit order is used when an investor wants to purchase a security at or below a specific price.
- Execution: The order will only be executed if the market price of the security drops to or below the limit price set by the investor. If the price does not reach this level, the order will not be filled.
- Sell Limit Order:
- Purpose: A sell limit order is used when an investor wants to sell a security at or above a specific price.
- Execution: The order will only be executed if the market price of the security rises to or above the limit price set by the investor. If the price does not reach this level, the order will not be filled.
- Price Control:
- Limit orders give investors control over the price at which they buy or sell a security, ensuring that they do not pay more or receive less than their desired price.
- No Guaranteed Execution:
- While limit orders guarantee the price, they do not guarantee that the order will be executed. If the market price does not reach the limit price, the order remains unfilled.
- Duration of the Order:
- Day Order: The limit order is valid for the trading day on which it was placed. If it is not executed by the end of the trading day, it is canceled.
- Good ‘Til Canceled (GTC): The limit order remains active until it is either executed or canceled by the investor.
- Use Cases:
- Buying Below Market Price: Investors might use a buy limit order to purchase a stock at a lower price than its current market value, aiming to get a better deal.
- Selling Above Market Price: Investors might use a sell limit order to sell a stock at a higher price than its current market value, aiming to maximize profit.
Example of a Limit Order:
- Buy Limit Order: Suppose a stock is currently trading at $50 per share, but an investor believes the stock is worth buying only if it drops to $45 or lower. The investor places a buy limit order at $45. If the stock price falls to $45 or below, the order is executed, and the investor buys the stock at $45 or less. If the price does not reach $45, the order is not executed.
- Sell Limit Order: An investor owns a stock that is currently trading at $100 per share. They want to sell it only if the price rises to $110 or more. The investor places a sell limit order at $110. If the stock price reaches $110 or higher, the order is executed, and the investor sells the stock at $110 or more. If the price does not reach $110, the order is not executed.
Conclusion:
A Limit Order is a useful tool for investors who want to control the price at which they buy or sell a security. By setting a specific price limit, investors can avoid overpaying for purchases or selling for less than they desire. However, because limit orders do not guarantee execution, they are best used when the timing of the trade is not as critical as achieving a specific price.
