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7 Things to Know About Limit Orders

Y ou can’t monitor the stock market all day long. Yet, you naturally want to take advantage of sudden changes in market pricing. Fortunately, there is a relatively simple solution for this: limit orders. With limit orders, you can tell your broker to buy or sell a stock when it reaches a specific price or better. Limit options aren’t the only type of order available, though. Learn about different types of orders and how you can use them to maximize profits and minimize losses in the market.

  • Limit orders allow you to instruct a broker to buy or sell when a stock reaches a specific price or better.
  • Stop orders help you minimize losses by triggering an order to sell if prices drop to a certain level.
  • Stop-limit orders allow you to set a pricing window in which a broker will buy or sell.

What Are Limit Orders?

Image via Flickr by lendingmemo_com

A limit order is an instruction to a broker to buy or sell a stock at a specified price or better. For example, if you wanted to buy shares of a particular stock for $100 or less, you can set a limit order that the broker will act on only if the shares get to a price of $100 or less.

You could take the same approach with selling stock as well, setting a limit order to sell shares of a particular stock once they reach a specific price on the market. For example, if you own stock that’s currently worth $60 per share, you could set a limit order for $70, so the broker will automatically sell the stock if the price reaches $70 or better.

What Is a Stop Order?

A stop order is very similar to a limit order, in that they both place an order to trade if the stock reaches a certain price on the market. However, a stop order is designed to minimize losses. A stop order, also referred to as a stop-loss order, triggers at the stop price or if the prices on the market get any worse.

Let’s say you own shares of stock at $10 per share — a good price for the stock. However, you know that if they drop to $8 per share, you want out. You could set a stop order for $8 so that the broker would automatically sell if prices drop to $8 or lower.

Brokers today often add “stop on quote” to make it clear that the stop order will only trigger if the price on the market has been met. You can also use a stop order as an entry order. For example, let’s say you wanted to open a position when a particular stock starts to go up in price. You could set a stop market order for a price that’s above the current price. Once the stop price is met, it becomes a regular market order.

Benefits of Limit Orders

With a limit order, you can more easily control your portfolio, even if you aren’t monitoring the market closely. This is particularly beneficial in a volatile market where the prices are constantly moving.

Setting a series of limit orders to buy or sell can help you capture those short-term market fluctuations. Even if you are away from your computer, your broker will trigger the trades for you. Additionally, if a trader thinks that a particular stock is undervalued, they may purchase a stock and then set a limit order to sell once the price per share goes up.

Drawbacks of Limit Orders

The biggest drawback of limit orders is that if you set the buy limit too low or the sell limit too high, the stock may not ever trade.

For example, let’s say that a particular stock is currently trading for $20 per share, and you set a limit order to purchase shares if it gets down to $15 per share. The stock could drop down to $16 per share, which is still a great price, before going back up to $19 per share. If you had set the limit order slightly higher, you could have grabbed the stock at a great price and enjoyed solid returns. However, because you set it too low, the trade was never made.

What Is a Stop-Limit Order?

Astop-limit order consists of both the stop price and the limit price. This type of order activates a limit order to buy or sell if a specific price is met in the market.

For example, let’s say that you purchase shares of a stock at $100 per share and expect the price to go up. However, you can also place a stop-limit order to sell the shares in case you were wrong and the price of the shares starts to drop. For instance, you could set the stop price at $90 and the limit price at $90.50. The limit order will only be filled if the limit price that you set is available. However, if the stock drops down to $88 per share, the order will be activated because that’s lower than the $90 stop price that you set.

The greatest risk of stop-limit orders is no fills or partial fills. For example, it’s possible for the stop price to be triggered and yet have your limit price remain unavailable. Even if you used a stop-limit order to minimize losses, if a particular stock started to drop in value, it might not close the trade. For instance, if you wanted to sell 200 shares at a limit price of $50, but only 100 were filled, you could still suffer further losses on the remaining 100 shares.

A stop order can prevent the risk of a partial fill or no fill, but because it’s a market order, you may find that your order was filled at a price substantially worse than what you expected. For example, let’s say you bought shares of a stock for $75 per share and have a stop order set at $70. If a major event like an earnings report release occurred and investors were disappointed, the market could open the next day at $60 per share. Your stop order would trigger, and you would have traded at $60, which is well below your stop price.

Why Traders Use Stop-Limit Orders

While there are some risks with stop-limit orders, traders use them because it allows them to stay on top of changes in the market pricing, even if they can’t monitor the market closely.

Benefits of Buy Stop-Limit Orders

A buy stop-limit order allows traders to control what they pay by establishing a maximum price per share. If the price increases to that price or higher, an order will trigger to buy. The stop price activates the order to purchase, and the limit price specifies the highest price per share that you’re willing to pay.

With a buy stop-limit order, you’re telling the broker to buy if a price gets to a certain point or higher, but only if you can pay a specific amount of less. In other words, it gives the broker a pricing window that you want to buy within.

Benefits of a Sell Stop-Limit Orders

This type of order tells the broker to sell shares of a particular stock if the price drops down to or below your stop price, but only down to a certain amount per share. In other words, you’re giving them a pricing window in which you want to sell.

If you’re entering a sell stop-limit order, it’s important to make sure that the stop price and limit price are both below the current bid price, or you run the risk that your order could trigger immediately. Many traders don’t believe sell stop-limit orders are an effective strategy for managing risk because there’s a possibility that the limit order may not be executed.

Now that you better understand the different types of orders you can use to limit losses or take advantage of short-term pricing changes in a volatile market, the next step is to learn some great strategies for trading.