A limit order in the financial markets allows participants to buy or sell a stock or other security at a specified price or better, providing them better control over trade execution prices. Traders can utilize limit orders to manage their investments more precisely.
- A buy limit order is executed only at the limit price or lower.
- A sell limit order is executed only at the limit price or higher.
While the price is guaranteed, there is no guarantee that the order will be filled, as execution depends on market conditions meeting the order’s criteria.
The alternative to a limit order is a market order, where the trade is executed at the current market price without a specified price limit.
Key Takeaways
- A limit order guarantees a transaction at the specified price or better.
- No guarantee exists for the order to be filled.
- Limit orders help control execution price but might miss opportunities in fast-changing markets.
- Can be combined with stop orders to mitigate large losses.
- Typically valid for a certain number of days, until filled, or canceled by the trader.
How Limit Orders Work
A limit order involves setting a pre-defined price to buy or sell a security. For example, if a trader intends to buy XYZ stock but limits the price to $14.50, they will only purchase if the price drops to $14.50 or lower. Likewise, to sell at a $14.50 limit, the trader waits until the stock price is at $14.50 or higher.
Limit orders offer traders control over the execution price, especially useful in volatile market conditions, and can be left open with specified expiration dates.
Limit Order Example
Imagine a portfolio manager who wants to buy Tesla Inc. (TSLA) but finds its $750 per share valuation too high. They might set a limit to purchase the stock if it falls below $650. Likewise, a sell limit could be placed on Amazon.com Inc. (AMZN) at $2,750 above its current trading price of $2,300.
Brokerage firms ensure logical limit orders and offer these services to investors, often free of charge.
Limit Orders vs. Market Orders
When placing a stock order, investors can choose between “at the market” or “at the limit.” Market orders prioritize speed over price, completing transactions immediately at current market prices. Limit orders, on the other hand, ensure execution at a specified price but only if the market reaches that level.
Analogous to car buying, you can either pay a dealer’s price or negotiate your preferred price and wait for the dealer to accept it. Similarly, market orders are pricedate-driven, while limit orders are price-driven, providing precise control over trade execution conditions.
Why Consider a Limit Order?
A limit order allows you to execute trades at desired price levels without monitoring markets continuously—a useful strategy to hedge risks and minimize losses.
How Does a Limit Order Work?
When placing a limit order, specify the security, quantity, price, and whether you intend to buy or sell. It won’t trigger until your desired market price is achieved, and even then, execution isn’t assured, particularly for highly volatile or low-liquidity stocks.
Distinguishing Limit Orders and Stop-Limit Orders
A limit order sets a defined price for buying/selling securities. In contrast, a stop-limit order adds another parameter where a specific price-difference dictates whether to fill the order.
Example: A limit order sells your stock at $15, if reached. A stop-limit order sets a criterion to sell only if the stock drops from $20 to $16 for instance.
Limit Order Duration
The duration of a limit order depends on your settings and broker policies. Many brokers default to day-only trades, canceling unexecuted orders at market close. Others offer intervals like 30 or 60 days, while some valid till filled or manually cancelled by the trader.
Why Limit Orders May Not Get Filled?
A limit order may go unfilled if market prices haven’t met your specified levels—like trading above your buy order or below your sell order. Low liquidity or high volatility, especially at IPO’s, might further impede limit order execution.
Related Terms: Stop Order, Market Order, Execution Price, Volatility.
