In trading, a limit order is a type of order that allows you to buy or sell a security at a specific price or better. Unlike a market order, which executes immediately at the best available price, a limit order gives you control over the execution price.
Here's how it works:
Buy Limit Order: You set a maximum price you're willing to pay for a security. The order will only execute if the security's price falls to or below your specified limit price.
Sell Limit Order: You set a minimum price you're willing to accept for selling a security. The order will only execute if the security's price rises to or above your specified limit price.
Example:
Let's say you want to buy shares of Company XYZ, which is currently trading at $50 per share.
Scenario 1: Buy Limit Order
You believe that $50 is too high and you only want to buy if the price drops. You place a limit buy order for 100 shares of Company XYZ at $48.
If the price of Company XYZ drops to $48 or lower, your order will be executed at $48 or a better (lower) price.
If the price never drops to $48, your order will not be filled.
Scenario 2: Sell Limit Order
You own shares of Company ABC, which is currently trading at $75 per share, and you want to sell them if the price goes up. You place a limit sell order for 50 shares of Company ABC at $78.
If the price of Company ABC rises to $78 or higher, your order will be executed at $78 or a better (higher) price.
If the price never reaches $78, your order will not be filled.
Key advantages of limit orders:
Price Control: You dictate the price at which your trade will execute, preventing you from buying too high or selling too low.
Risk Management: Can be used to limit potential losses by setting a sell limit order below your purchase price or to secure profits by setting a sell limit order above your purchase price.
Potential disadvantages:
No Guarantee of Execution: There's no guarantee that your limit order will be filled, especially if the market moves quickly and the price never reaches your specified limit.
Missed Opportunities: You might miss out on a trade if the price briefly touches your limit but then moves away before your order can be filled.