Together with the market, day, stop order, etc., a limit order is a type of a trade order - an instruction to buy or sell a security on a stock, bond, derivative, commodity, or cryptocurrency exchange market.
What Is a Limit Order?
It is the use of a specific price as a limit when buying or selling a security. This gives the trader control over the trade price. However, the order may never be executed. Therefore, the purpose of limit orders is rather to control the price than to execute them. There are two types of Limit Orders: buy and sell. A buy LO can be executed only at the limit price or lower. A sell LO can be executed only at the limit price or higher. For example, a trader whose budget is $15 can use a LO to buy a stock only at $15 or lower. If the trader is looking to sell shares of this stock with a $15 limit, they will not sell any shares until they cost $15 or higher.
Both buy and sell orders can have extra constraints, such as fill or kill (FOK) and all or none (AON). The FOKs are either filled (executed) completely on the first attempt or canceled right away. The AONs have a condition that the order must be filled with the entire number of shares specified, or not filled at all. This is why limit orders may never be executed.
When to Use
Traders typically use LOs when a stock is rising or falling very quickly, for a fear of getting a bad fill from a market order. Besides, it can be useful if a trader is not in a rush to buy or sell a security. In this case, they just have a specific price in mind at which they can later buy or sell that security, leaving their LO open with an expiration date. Traders may also split their main order into much smaller to get a cost average effect.
It may take you some time until you are able to effectively place LOs. At first, you may set them too low or too high, and they may never be filled. However, with time and experience, you will find the spot that gets you a good price while making sure that your order actually gets filled.
Limit Order vs Market Order
Unlike a market order, a LO is not executed instantly, so the trader needs to wait until their ask or bid price is reached. That’s why some brokers may charge more to execute a LO than they do for a Market Orders. Another difference is that a LO is about a specific price or better whereas a MO is about the best available price.
Limit Order vs Stop Order
A stop order is used to limit losses and can be triggered by short term price fluctuations. A LO can be used to set a stop order. The differences between these order types are as follows:
A LO trades at a price that is equal to or better than a market price whereas a SO trades when the price moves beyond the desired target.
Investors use a LO to protect themselves from buying a stock at a price that is too high or selling it at a price that is too low. The purpose of a Stop Order is to limit losses. If a stock price is moving in a direction opposite of what the investor would like, a Stop Order places a ceiling on potential losses.
Whereas a LO involves a higher commission from brokers, for a Stop Order, a trade price may be worse than a stop price.
There is also a combined order type known as a stop limit order. It includes two prices: a stop price and a limit price. Traders can use this order type to activate a LO when a specific stop price has been met.
For example, if a trader buys shares at $150 and expects the stock to rise, they can place a stop limit order to sell the shares if this expectation is not met. If the trader sets the SP at $130 and the LP at $131, the order will be activated if the stock trades at $130 or lower. However, a LO will be executed only if the chosen LP is available in the market. If the stock drops overnight to $129 per share, then the order will be activated, but it will not be executed immediately because there are no buyers at the set LP of $131 per share.
A stop limit order also allows setting the same stop and limit prices. An SLO has two main risks: no fills or partial fills. The SP can be triggered and the LP can remain unavailable. If a trader uses an SLO as a stop loss to exit a long position after the stock started to go down, it might not close their trade. Even if the LP is available after an SP has been triggered, the entire order may not be filled if that price did not have enough liquidity.
For example, a trader would like to sell 300 shares at an LP price of $60. 200 shares were filled, and the trader may suffer further losses on the remaining 100 shares. A stop order helps avoids the risks, but because it is a market order, the trader may have their order filled at a price much worse than they were expecting. For instance, if they have set a SO at $50 on a stock that they bought at $60 per share, the company will report earnings after the market closes and opens the next day at $40 per share. The stop order will be activated, and the trader can be out of the trade at $40, which is lower than their SP of $50.
A limit order is an order type that uses a specific price as a limit when buying or selling a security. A buy it can be executed only at the limit price or lower. A sell it can be executed only at the limit price or higher.