Using a Limit Order Helps You Invest Safely

A limit order acts like a standing set of instructions for your trade. You're giving your broker the prices that you want to "trigger" your order.

If you're buying, you want to pay the lowest price possible. If you're selling, you want to sell at the highest price possible.

In theory, a limit order will give you some control over the price at which you buy or sell shares.

What is a Limit Order?

This is the order you use when you want to execute a trade at a specific price.

When you enter your order, and select the "limit" option, you'll be asked for your "limit price":

  • If you enter a buy order with a limit, then your order won't activate until the price of the stock is at or below your limit price.
  • If you enter a sell order with a limit, then your order won't activate until the price of the stock is at or above your limit price.

The reason it's called a limit price is because your trade won't execute unless the stock price is better than a price you specified.

There are two types of limit order you can use:

1) Market Limit Order:

    As soon as the limit price is reached, the order changes to a "market order" and is executed at the best price available at that time.

2) Standing Limit Order:

    As soon as the limit price is reached, the order is executed, but only if the price is at or better than the limit price.

The difference between the two is subtle, but very important. In the world of high frequency trading, prices can change in an instant. A market order could be executed at a price far away from your limit price. With a standing limit order, the limit remains in place.

Why would you place a limit order?

Most investors and traders use these orders when they can't monitor the markets. For most of us, that's pretty much every day.

With this order, your broker watches stock prices for you and trades when prices match your order conditions.

Factors affecting Limit Orders

The main factor is where you set the limit price. The stock price may never reach your limit and your order will not execute. Or, the stock reaches your price limit, your order gets executed, and then the stock price reverses.

Which means the level of volatility in the stock you're buying is a secondary factor. The more a price jumps around, the more likely you are to run into one of the two scenarios mentioned above.

Unfortunately, if you want to use limit orders there isn't too much you can do about these problems, because you won't be a problem until your order has executed. In the industry, it is called ex post regret.

When to use a limit order

Limit orders are best used when you can't watch your stocks, but you know you want to buy/sell when your stock reaches a certain price.