What is Limit Order and How Does it Work?

A limit order can be used to take advantage of price differences in different markets or to sell or purchase a security when you cannot watch the market closely. Limit orders are often used to protect your portfolio from losses caused by irrational price changes.

Limit orders can be useful tools to help shield investors from extraordinary stock market volatility, such as “flash crashes” because they don’t execute unless criteria are satisfied. Limit order usage is a good habit for investors to get into, especially as automated trading gains popularity and periodically disrupts the stock market. 

What is a Limit Order?

An order to purchase or sell a stock at a certain price or higher is known as a limit order. In simple words, a limit order enables an investor to sell or acquire the shares when a stock price hits a certain level. Sell limit orders may only be carried out at the limit price or higher, and buy limit orders may only be carried out at the limit price or lower.

The execution of a limit order is not guaranteed. Only if the market price hits the limit price, then only the order will be executed. This is why limit orders are sometimes called “pending” orders. 

To understand the limit order meaning better, let’s take an example. For instance, say you wanted to buy shares of XYZ stock at ₹50 per share, but you could not watch the market closely. You can place a limit order to buy XYZ stock at  ₹50 per share, and your order would be executed if the shares traded at  ₹50 or lower. 

Buy Limit Order

A buy limit order is appropriate if an investor anticipates that the value of an asset will decrease. A market order to purchase a stop limit order is a preferable option if the investor doesn’t worry about paying the current price or even more if the asset starts to appreciate or rise.

Sell Limit Order

You can execute a sell limit order only at the limit or maximum price or above. So a broker will only sell your shares in response to a sell limit order if the stock price climbs over a predetermined limit price.

When to Place a Limit Order

This question cannot be satisfactorily answered because it is based on the objectives and risk tolerance of each investor. However, as a general rule, investors should place a limit order when buying or selling a security at a specific price and are willing to wait for that price to be reached before the trade is executed.

Limit orders can be especially useful when an investor is trying to target a particular price point for security and is not concerned about getting the best price for the trade. 

For example, an investor might place a limit order to buy a stock at ₹50 per share, even though the current market price is  ₹51 per share. In this case, the investor is willing to wait for the stock to reach its target price before buying it, even if that indicates missing out on a small amount of potential profit.

Limit orders can help you prevent slippage or the gap between the price you anticipate spending for a stock and the value you eventually pay, which might be a smart idea when you’re trading many shares. Foreseeing how much slippage could happen when placing a market order is challenging. However, using limit orders, you are certain of the price you will pay for the number of shares you choose.

Trading might also become less emotional by using limited orders. You can put a limit order if you’re concerned about selling or buying a stock at the incorrect moment and then proceed with your day without worrying about exactly timing the market.

Additionally, limit orders are also useful when trading a stock that doesn’t move regularly. For instance, it could take some time for a market order to be filled if you wish to purchase stocks of a small business with little trading activity. Limit orders can assist you in this situation so that you may place your purchase quickly and yet receive the desired pricing.

Benefits of a Limit Order

A limit order can benefit investors because it allows them to specify the price at which they are willing to buy or sell a security. This can help investors to get the best possible price for their security. Limit orders can also help to protect investors from market volatility.

Thus, investors wishing to safeguard themselves against market short circuits may consider limit orders as they allow investors to place restrictions on a purchase or sell order. 

The primary benefit of using a limit order is the ability to specify the highest price at which you wish to open or terminate your positions. The deal will go through if the stock price hits that mark. Consequently, limit orders enable you to trade at a specified level without continuously checking the asset price.

Limit orders are becoming even more important as computerized trading becomes more prevalent.

Conclusion

Limit orders are becoming increasingly significant as the market’s speed quickens. Computer algorithms perform more than 50% of all stock market deals daily. Limit orders which restrict the purchase and sale prices might help investors prevent portfolio damage from big market movements like the GameStop frenzy.

Limit orders could be the best approach to guarantee that you will take advantage of all trading opportunities, but remember, they are imperfect. It’s crucial to realize that the exact tool that shields you from the severe loss may also shield you from unexpected benefits. Consider contacting a financial counselor if you have any queries regarding investing in your portfolio.

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