There are many tools you can use when investing in the stock market to help you make a profit or reduce a loss. The different types of orders to your stockbroker are a toolkit that lets you pick the right tool for the right job.
These stock market tools let you choose when and for how much you will buy or sell a stock.
One of the most important tools in your stock buying toolkit is the limit order.
The limit order limits the price you are willing to pay or the price at which you are willing to sell. You are telling the market you will sell (or buy) at this price.
Unlike the market order, which executes your buy or sell immediately regardless of price, the limit order may or may not go to the top of the list for execution by your stockbroker. If the price on your limit order is the best ask or bid price, it will go to the top and may be filled very quickly.
If it is not, it will slot in among the other orders that are away from the market. As other orders are filled, your order may work its way to the top. On the other hand, better orders may come in and push your order down the list.
Limit orders are a trader's best friend because they provide discipline to buying and selling and fix a price the trader can live with in most cases, but they do have some flaws. The important point is that your order will only be filled at your price or better.
Placing a Limit Order
A limit order, whether given to a stockbroker or entered into your advanced trading platform, has the same five components:
- Buy or sell
- Number of shares
- Order type
For example, if you wanted to buy 100 shares of XYZ using a limit order, here's how you would express it:
Buy 100 shares XYZ limit 33.45
This order tells the market you will buy 100 shares of XYZ, but under no circumstances will you pay more than $33.45 per share.
An important point to remember about limit orders is they are not absolute orders. Your limit order to buy XYZ at $33.45 per share can't be filled above that price, but it can be filled below that price. If the stock's price drops past your limit before it is filled you could pay less than $33.45 per share.
It works the same way on the limit sell order. If you enter a limit sell order for $33.45, it can't be filled for less than that amount. However, if the stock rises above that price before your order is filled, you could receive more than your limit price.
It will take some experience to know where to set limit orders. If you set limit buy orders too low they may never be filled, which does you no good. The same is true for limit sell orders. With some experience you'll find the spot that gets you a good price and your order filled.
The simple limit order could be a problem for traders or investors not paying attention to the market. For example, you enter a sell limit order on a stock that is a few dollars per share over the market price and a buy limit order a few dollars per share under the market. This way you will make a profit if the stock rises and add to your holdings if the stock dips.
Not a particularly inspired trading strategy, but one that seems to have your bases covered. You take off for a long weekend and return on Monday to find your sell limit order has been filled. You are happy with your small profit until you notice that the company is a merger target and the stock has jumped $15 per share.
Unfortunately, your limit sell order got you out of the stock with a $2 per share profit, leaving $13 per share on the table. You can imagine the reverse of this scenario if the stock dropped like a rock and your buy limit order filled as the stock was in a free fall.
The point is simple limit orders are excellent tools, but they are not foolproof. In a highly volatile market, limit orders like the example above may be tricky. Be sure you can live with the results. If you want to buy or sell a stock, set a limit on your order that is outside daily price fluctuations and live with the outcome. Either way you have some control over the price you pay or receive.