Using Limit Orders When Buying or Selling Stocks

Take more control over your trading outcomes

When managing your stock market trades, many techniques and tools exist to help you make a profit or reduce a loss. For example, the different types of buy and sell orders available to traders essentially offer a toolkit that lets you choose the right tool for the right job.

You can use these different trade types to control when and for how much you want to buy or sell a given stock. Many traders find the limit order to be one of the most important and useful tools in their arsenal.

What's a Limit Order?

A limit order gets it name because using it effectively sets a limit on the price you are willing to pay or the price at which you are willing to sell a given stock. You tell the market that you'll sell or buy, but only at the price set in your limit order.

Unlike the market order, which executes your buy or sell transaction 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 not, it will get in line with the other trade orders that are priced away from the market. As other orders get filled, your order may work its way to the top. On the other hand, orders priced closer to the current market may come in and push your order down on the list.

Although they do have some flaws, some consider limit orders a trader's best friend, because they provide a certain discipline to buying and selling by fixing a price the trader can live with. Your order will only be filled at the price you set, or better.

Placing a Trade

A limit order, whether given to a stockbroker or entered into your advanced trading platform, has the same five components:

  • Buy or sell transaction type
  • Number of shares
  • Security
  • Order type
  • Price

For example, if you wanted to buy 100 shares of a stock with the ticker XYZ, and the maximum you wanted to pay per share was $33.45, using a limit buy order, you would express it as follows:

Buy 100 shares XYZ limit 33.45

This order tells the market that you will buy 100 shares of XYZ, but under no circumstances will you pay more than $33.45 per share for the stock.

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 won't be filled above that price, but it can be filled below that price. If the stock's price falls below your set limit before the order's filled, you could benefit and pay less than $33.45 per share.

The transaction works the same way for a limit sell order. If you enter a limit sell order for $33.45, it won't be filled for less than that price; in other words, your stock won't be sold for any less than $33.45 per share. If the stock rises above that price before your order is filled, you could benefit by receiving more than your limit price for the shares.

Benefits of Experience

It takes 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 holds true for limit sell orders. With some experience, you'll find the spot that gets you a good price while making sure your order actually gets filled.

An Example

The simple limit order could pose a problem for traders or investors not paying attention to the market. For example, you could enter a sell limit order on a stock that currently sits a few dollars per share over the market price and a buy limit order with a price set at 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 price drops.

While not a creatively inspired trading strategy, it's one that seems to have your bases covered. You might choose to take off for a long weekend, only to return Monday to find your sell limit order has been filled.

You feel 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 only a $2 per share profit, leaving the additional $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.

Limit orders make excellent tools, but they are certainly not foolproof. In a highly volatile market, limit orders like the example above may be tricky, causing you to lose out on additional profits or shares because orders execute too soon.

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.