Limit Order

Definition

A limit order is a type of order to buy or sell a security at a specified price or better. It ensures that the investor does not pay more than a predetermined price for a purchase or receives less than a specific price for a sale. This type of order plays a crucial role in stock markets as it allows investors to control their trades and manage risk effectively.

5 Must Know Facts For Your Next Test

1. Limit orders can be set for both buying and selling securities, providing flexibility in trading strategies.
2. When placing a limit order, if the specified price is not met, the order may remain unfilled until market conditions change.
3. Limit orders can help traders avoid unexpected price changes that can occur with market orders.
4. They are particularly useful in volatile markets where prices can fluctuate rapidly.
5. Limit orders can be partially filled if there are not enough shares available at the specified limit price.

Review Questions

• How do limit orders compare to market orders in terms of execution and control over trade prices?
  • Limit orders offer more control over trade prices compared to market orders. With limit orders, investors set specific prices at which they want to buy or sell, ensuring they don't pay more or receive less than desired. In contrast, market orders execute immediately at the current market price, which may lead to unexpected costs if the price fluctuates significantly.
• Discuss how limit orders can be beneficial in volatile market conditions and provide an example of such a scenario.
  • In volatile market conditions, limit orders help investors manage risks by allowing them to set maximum purchase prices or minimum sale prices. For example, if a stock's price is fluctuating wildly between $50 and $70, an investor might set a limit order to buy at $55. This way, they avoid overpaying if the stock jumps up rapidly and only purchase when it reaches a more favorable price.
• Evaluate the potential drawbacks of using limit orders and how they may impact trading strategies in stock markets.
  • While limit orders provide control over execution prices, they also come with potential drawbacks such as unfilled orders. If the market price never meets the limit set by an investor, the order will remain pending and may miss out on potential profits if prices increase. Additionally, using only limit orders might prevent traders from taking advantage of sudden market opportunities that require immediate action. This can lead to missed trades or delays in reacting to changing market conditions.

Related terms

Market Order:

A market order is an instruction to buy or sell a security immediately at the current market price, without any limits on the price.

Stop Order: A stop order is an order to buy or sell a security once it reaches a certain price, known as the stop price, often used to limit losses.

Order Book: An order book is a list of buy and sell orders for a specific security, organized by price level, which shows the supply and demand dynamics in the market.