It is very important for a trader to get the best price possible while placing an order in the stock market. A buyer always wants to buy a stock at the lowest price possible and a seller wants to sell at the highest price possible.
So, for managing the stock market trades, various methods and techniques exist to assist you to make a good profit and minimize loss. One of such most useful tools for crafting investing success is called a ‘limit order’. Limit orders are highly prominent in use as it helps you to avoid portfolio damage from wild price swings.
What is a Limit Order?
A limit order allows investors to purchase or sell a stock at a specified price or better. In case of buy limit orders, the order will only get executed below or at the limit price, while for selling limit orders, the order will only get executed above or at the limit price. This stipulation allows traders to have better control over the prices they want to execute transactions and that ultimately shows in their trading performance.
With a buy limit order, the buyer is guaranteed to pay that stock price or less. While the price is guaranteed, the filling of the limit order is not, and the limit order will not be executed unless the stock market price reaches the limit price.
Stock limit orders are not a 100% order execution guaranteed because buy limit orders are executed chronologically and it is not necessary that a buyer will surely find a seller at the limit price. In case the asset does not reach the specified price, the order will not be executed and the trader may skim out on the trading opportunity.
This can be constructed with a market order, wherein the order is executed as quickly as possible at the present market price without defining any price cap.
Let’s make it more simple with how limit order works with a quick example:
Buy Limit Order
Assume, you decided to buy 100 shares of an ABC company, and the maximum price you want to pay is Rs. 25.50 per share. In this scenario, you would choose a buy limit order option like this:
Buy 100 shares ABC, limit 25.50
This buy limit order states to the market that you will buy 100 shares of ABC, however under no conditions will you pay more Rs. 25.50 per share for the stock.
The limit orders are not absolute orders. Your buy limit order to ABC at Rs. 25.50 per share will not be executed above that price and it is beneficial for you if it executes below the limit price. In case, the price of the stock falls below your set limit before the order is executed, you could benefit and if the price goes up, and the limit price is not reached, the trade won’t execute and the funds for the purchase will remain in your trading account.
Sell Limit Order
The transaction works similarly for a sell limit order as well. If you place a sell limit order for Rs. 25.50, it won’t be executed for less than this price and is displayed like this:
Sell 100 shares ABC, limit 25.50
In short, your buying stock won’t be sold for any price less than Rs. 25.50 per share. In case, the stock price rises above Rs. 25.50 before your order is executed, you could benefit by receiving more than your limit price for the stock. On the other hand, if the stock price falls and your limit price is not reached, the trade won’t be filled and the stocks will remain in your demat account.
When to place a Limit Order?
You can place limit orders especially when you are not in a hurry to buy or sell stocks. The limit orders are not executed immediately, so you are required to wait until your ask or bid price is reached. Usually, limit orders are placed on major resistance and support levels and it allows you to get best buying and selling prices. You can also divide buy/sell orders into multiple smaller limit orders to get an effective average cost.
Apart from this, it takes some experience to know where or when to set the limit prices. If you place a buy limit order too low, it might never be executed, which would do you no good and similarly, holds true for the sell limit orders. Once you get some experience, you will find the right spot that gets you a better stock price while making sure your order actually gets executed.
What are the benefits of Limit Order?
The main advantage of placing a limit order is that you can place an order on the maximum price at which you want to open or close your positions. In case, the stock price reaches that level, the trade will be carried out. Therefore, limit orders allow you to execute a tarde at a defined level without having to constantly monitor the asset price.
Moreover, limit orders can also be placed after or before market hours as some brokers also allow a limit order for buying and selling stocks to be placed before and after market hours. The order will expire automatically if unfilled in the next trading session after the order is placed.
What are the risks of Limit Order?
The biggest risk with limit orders is that there is no assurance of execution of such orders, because the stock price may never reach the amount that you have specified. In other words, if there was a specific position that you required to close or open, you would be at risk of it never being fulfilled, which might impact your trading plan.
The Bottom Line
Limit orders may be an ideal way to prevent missing a trading opportunity, but they are certainly not foolproof. Here it is important to understand that the same tool that protects you from extreme loss can also prevent you from realizing unanticipated gains.
In the highly volatile market condition, limit orders like the example above may cause you to lose out on additional profits or stocks, since they may be filled too fast.
In case you want to buy or sell a stock, fix a limit on your order that is outside/beyond daily price fluctuations. Assure that the price of the limit is fixed at a point at which you are satisfied with the outcome. Either way, you should have some control over the buying and selling prices.