What is a Limit Order? When to place a Limit Order?

A limit order is a type of order that allows traders to buy or sell a security at a specific price or better, offering more control over trade execution. Unlike a market order that executes immediately at the best available price, a limit order ensures that the trade only goes through when your target price is met. A buy limit order is placed below the current market price and executes only when the price falls to your set level or lower. On the other hand, a sell limit order is placed above the current market price and executes only when the price rises to your set level or higher. This strategy is useful for managing risk and targeting precise entry and exit points.

What Is a Limit Order?

Limit order meaning refers to an instruction given to your broker to buy or sell a security at a specific price or better. This “or better” condition means a buy limit order is executed at the specified price or lower, while a sell limit order is triggered at the specified price or higher. It offers more control over your trade execution and helps you avoid unfavourable market prices.

What Is a Buy Limit Order?

A buy limit order instructs your broker to buy security only at or below a specific price you set. This ensures you don’t overpay for the security. For example, if you place a buy limit order for Stock A at ₹100, your order will only be filled if the stock price reaches ₹100 or lower.

What Is a Sell Limit Order?

A sell limit order instructs your broker to sell a security only at or above a specific price you set. This helps you lock in profits or limit losses. For instance, if you place a sell limit order for Stock B at ₹50, your order will only be filled if the stock price reaches ₹50 or higher.

How Limit Orders Work

When you place a limit order, whether a buy limit order or a sell limit order, it doesn’t just magically get executed. Instead, it enters the stock exchange’s order book, where it waits until the price reaches your specified limit. Only then will the order be completed.Think of the order book as a centralised ledger that keeps track of all pending buy and sell orders for a particular security. It’s a dynamic record of market participants’ intentions, constantly updated as new orders are placed, filled, or cancelled.

Your limit order, with its specific price and quantity, joins this queue of pending orders. It patiently waits its turn, hoping to match with a corresponding order at your desired price.

Here is how this works:

• Buy Limit Orders: Your buy limit order will be placed in the order book among other buy orders, ranked by price. Higher-priced orders are prioritised, as they indicate a greater willingness to buy.
• Sell Limit Orders: Your sell limit order will join the queue of sell orders, also ranked by price. Orders with lower prices are given priority, as they indicate a greater willingness to sell.

Your limit order will remain in this order book queue until one of these things happens:

• Filled: A matching order appears at your limit price or better, and your trade is executed.
• Cancelled: You decide to cancel the order before it’s filled.
• Expired: The order reaches its expiration time, which could be the end of the trading day or a specified time you set.

The order book is crucial in stock market transparency and price discovery. It provides a real-time view of market demand and supply for a particular security. By understanding how limit orders interact with the order book, you can better understand how stock prices are determined and how your trades are executed.

So, the next time you place a limit order, you can remember that it is not just a simple instruction to your broker; It’s part of the active order book, waiting for the right moment to be matched and executed in the stock exchange.

Limit Order Example

Suppose you want to buy 100 shares of Company XY but are unwilling to pay more than ₹50 per share. You can place a buy limit order for 100 shares at ₹50. Your order will be executed if the stock price reaches ₹50 or lower. If the price does not reach your limit, your order will remain pending until it’s filled, cancelled, or expires.

When to place a Limit Order?

1. You want price control: If you’re only willing to buy or sell at a specific price or better.
2. The market is volatile: To avoid slippage or unfavorable prices.
3. You’re not in a hurry: Willing to wait for the market to reach your desired price.
4. You’re trading less liquid stocks: To avoid wide bid-ask spreads.
5. You have a specific strategy: Like setting entry points in technical setups.

Limit orders are ideal when price matters more than execution speed.

Advantages of Limit Orders

1. Limit orders provide you several advantages with more control and precision in their stock market activities allowing them to set specific prices at which they want to buy or sell. This helps avoid unexpected price fluctuations and ensures trades happen only at desired prices.
2. Price Control: This is the primary advantage of limit orders. Unlike market orders, executed at the prevailing market price, limit orders give you the power to set a specific price you’re willing to buy or sell. This ensures that you don’t overpay when buying or sell too low when selling. You’re in the driver’s seat, dictating the price you will enter or exit a trade.
3. Reduced Risk: By setting a limit price, you effectively create a safety net for your trades. Buy limit orders prevent you from buying at inflated prices, while sell limit orders help you avoid selling at unfavourable lows. This reduces the potential for losses and enables you to manage risk more effectively.
4. Discipline: Using limit orders can instil discipline in your trading. It forces you to think strategically about your entry and exit points, preventing impulsive decisions driven by emotions or market noise. By setting predefined price limits, you stick to your trading plan and avoid chasing prices or panic selling.

Disadvantages of Limit Orders

While limit orders offer significant advantages, they also come with certain limitations that traders need to be aware of:

1. Non-Execution: One of the main drawbacks of limit orders is the possibility of non-execution. If the market price doesn’t meet your specified limit, your order might not be filled. This can be frustrating, especially in volatile markets where prices fluctuate rapidly.
2. Missed Opportunities: In volatile markets, a limit order might prevent you from capitalising on favourable price movements beyond what is limit price in trading. For example, if you have a buy limit order at ₹100, and the price quickly jumps to ₹105, your order won’t be filled, and you might miss out on potential profits.
3. Partial Execution: Another potential issue is partial execution. Your limit order might be partially filled if there aren’t enough buyers or sellers at your specified price. This means you might only get a portion of the shares you intended to buy or sell, which could disrupt your trading strategy.

By understanding these advantages and disadvantages, you can make informed decisions about when to use limit orders and how to incorporate them effectively into your trading plan.

How Long Does a Limit Order Last?

The duration of a limit order can vary depending on the broker and the type of order. Some limit orders are “day orders,” which expire at the end of the trading day if not filled. Other orders might be “good-til-cancelled” (GTC) orders, which remain active until you cancel them.

Difference Between Limit Orders vs Market Orders

Common Reasons Why Limit Orders May Not Execute

1. Price Doesn’t Reach Limit: The market price never hits your set limit price, so the order stays unfilled.
2. Insufficient Market Volume: There aren’t enough shares available at your limit price to fill your order completely.
3. Order Expiry: Your limit order expires if it’s set as a day order and the price doesn’t reach the limit within the day.
4. Partial Fills: Only part of your order gets executed if there aren’t enough shares at your limit price.
5. Market Volatility: Rapid price changes can cause your order to miss the target price.

Conclusion

Limit orders are valuable tools for traders seeking greater control and precision in their stock trading activities. You can understand how limit orders work, their advantages and disadvantages, and the reasons for potential non-execution. You can also learn other than limit order what are stock market order types? You can incorporate them effectively into your trading strategies and improve your chances of success in the stock market.