Limit orders allow traders and investors to take advantage of price swings without constantly watching the market.
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What Is a Limit Order?
When an investor instructs their broker (usually via a trading application on their phone or computer) to buy or sell a stock on their behalf, they do so with an order. There are several different types of orders, but limit orders are one of the most useful.
A limit order instructs a broker to buy or sell a particular stock at a specific price or better as soon as possible. The order remains valid until it expires. This gives the investor the ability to automatically buy or sell a stock at a price they’ve chosen if and only if the stock in question reaches that price.
Limit Orders at a Glance
What? Buy or sell shares of a stockWhen? Once limit price is reached or exceededPrice? Specified limit price or better
Limit Buy Order Example
If Stock X currently trades at $100 per share, and an investor wants to own it but knows it tends to bounce around between about $85 and $105 per share, they might place a limit buy order with their broker with a limit price of $86. This way, the stock will automatically be purchased on their behalf the next time its price falls to that level, which allows them to keep their cost basis as low as possible without watching the market 24/7.
Limit Sell Order Example
On the other hand, if an investor has a target price (a price at which they plan to sell) in mind for a particular stock they own, they can place a limit sell order with a limit price equal to their target price. This way, the stock will be sold on the investor’s behalf automatically if and when it reaches their target price, so they don’t need to monitor the market constantly in order to spot their opportunity.
Do Limit Orders Expire?
Limit orders are customizable, so any time an investor places one, they can select how long they want the order to be valid for. A limit order can be set to expire at the end of the current trading session or after a certain number of days or weeks. Alternatively, it can be set to remain valid until it is canceled manually.
Do All Limit Orders Execute?
Because limit orders expire, and because they execute only at the specified limit price or better, many never execute. For instance, if a trader expects a lot of volatility in a stock they own over the course of a particular week due to an upcoming earnings call, they may place a limit sell order with a price 25% higher than the stock’s current price that expires at the end of the week. If the stock doesn’t reach their limit price before the week’s end, the order will expire unexecuted.
When Should You Use a Limit Order?
Limit orders are perfect for investors who have identified target entry and exit prices for the stocks they are interested in. For each stock they are interested in buying, an investor can create a limit buy order that is good until canceled with a limit price equal to their planned entry price for that stock. Similarly, for stocks they already own, an investor can create a limit sell order that is good until canceled with a limit price equal to their planned exit price for that stock.
That being said, any investor who doesn’t like to watch the market constantly could benefit from using limit orders instead of market orders in certain cases. Limit orders can be especially useful during periods of high volatility because they allow investors to take advantage of price swings without remaining glued to their trading app all day long. Limit orders are useful for vacations and trips out of cell phone service for the same reason. They essentially eliminate the need for market watching in the short term.
What Other Order Types Are There?
Limit orders are only one of three main categories of orders an investor might use to buy or sell shares. The others—market and stop orders—function a little differently.
Market Orders
Market orders are the most simple and straightforward—they simply instruct a broker to buy or sell a particular stock at the best available price as soon as possible. They don’t guarantee any specific price, so they execute at the best market price available, which is usually close to the last price quoted for the stock on its exchange.
For stocks with low trading volume and wide bid-ask spreads, however, market orders can be risky, as market price can change more significantly between trades. For this reason, market orders are best suited for large, popular stocks that trade on major exchanges, with good liquidity and high trading volume.
Stop Orders
Stop orders are very similar to limit orders but with one important difference—once the specified stop price is reached, the order becomes a market order and executes at the current market price regardless of supply and demand.
While limit orders execute only at a specified price or better, stop orders are triggered if a stock passes a specific price, whether that price is still available or not. For this reason, a stop order can sometimes execute at a less favorable price than the stop price specified by an investor.
Whereas limit orders are used to take advantage of opportunities that may arise while an investor is away from their phone or computer, stop orders are used to automatically lock in gains or minimize losses if certain price changes occur.
