Limit orders are increasingly important as the pace of the market quickens. According to CNN, computer algorithms execute more than half of all stock market trades each day. Limit orders that restrict buying and selling prices can help investors avoid portfolio damage from wild market swings such as investors have seen with shares of GameStock lately. If you have any questions about whether limit orders are right for you, speak with a financial advisor in your area.
What Is a Limit Order?
A limit order allows an investor to sell or buy a stock once it reaches a given price. A buy limit order executes at the given price or lower. A sell limit order executes at the given price or higher.
The order only trades your stock at the given price or better.
But a limit order will not always execute. Your trade will only go through if a stock’s market price reaches or improves upon the limit price. If it never reaches that price, the order won’t execute.
For example, you think Widget Co. is currently overpriced at $15 per share. If you want to invest, you could issue a limit order to buy Widget Co. at $10 or less. Your broker will only buy if the price ever reaches that mark or below.
Traders can set a limit order indefinitely or with an expiration date.
Limit Orders vs. Stop Orders
Stop orders and limit orders are very similar. Both place an order to trade stock if it reaches a certain price. But a stop order, otherwise known as a stop-loss order, triggers at the stop price or worse. A buy stop order stops at the given price or higher. A sell stop order hits given price or lower.
A limit order captures gains. A stop order minimizes loss.
Your Widget Co. investment at $10 per share looks good, but might decline. Setting a stop order for $8 per share would sell shares of Widget Co. as soon as they dip to $8 or lower.
Limit Orders vs. Stop-Limit Orders
A limit order is visible to the entire market. Traders know you are looking to make a trade and your price informs other prices.
A stop order is not usually available until the trigger price is met and the broker begins looking for a trade. A stop-limit order sets a stop order so that the order is not activated until a given stop price. You can then set a limit order so that the trade doesn’t execute until a given limit price is reached.
A stop-limit order on Widget Co. could have a stop price of $8.50 and a limit price of $8. The order would not activate until Widget Co. declined to $8.50, but your trade wouldn’t happen until the stock dropped o $8.
Why Use a Limit Order?
Traders who may not want to miss an opportunity could use limit orders to their advantage.
A limit order may provide control over your portfolio even if you aren’t currently monitoring the stock market. You might be at lunch during a period of high volatility in the market, but your brokerage (or more likely its computer) will trigger the trades no matter what.
Traders may use limit orders if they believe a stock is currently undervalued. They might buy the stock and place a limit order to sell once it goes up. Conversely, traders who believe a stock is overpriced can place a limit order to buy shares once that price falls.
Market volatility may also create opportunities a trader doesn’t want to miss. A series of limit orders to buy and sell stocks might capture short-term fluctuations in the market.
Downsides to Limit Orders
If you set your buy limit too low or your sell limit too high, your stock never actually trades.
Let’s say Widget Co. is currently trading at $15 per share and you set your limit order to buy at $10. The stock dips down to $11 but never goes lower before returning to a $14 per share. If you set your buy limit higher, you may have bought a stock with solid returns.
Meanwhile, you could set your buy price too high or your sell price too low. Your stock trades but you leave money on the table.
For example, assume you bought shares of Widget Co. You set a sell limit order at $15 per share, believing this is as high as the stock will ever go. The stock goes to $15 and your order goes through. The stock reaches $18 a share shortly after. By setting your sell limit too low you may sell your stock early and miss out on potential additional gains.
Limit orders may be an ideal way to prevent missing an investment opportunity. That’s especially true if you’re concerned (and what investor shouldn’t be thinking about this?) about getting hammered by will swings in the prices of securities. If you’re concerned that you’re buying too high or selling too low, however, you might want to do some homework or consult an expert.
- Whether you have limit orders, trading after hours or any other investment methods on your mind, you may want to meet with a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with local financial advisors in just five minutes. Get started now.
- In most cases, you’re going to want a diversified portfolio. This means that your investments range from different kinds of stocks to various bonds and more. You can determine your own asset allocation based on your risk tolerance and time horizon.
Photo credit: ©iStock.com/da-kuk, ©iStock.com/Rowan Jordan, ©iStock.com/da-kuk
Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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