If you’re looking to invest in the stock market, there are several different ways you can go about buying and selling stocks. One popular method is to use limit orders. In this article, we’ll explain what limit orders are, how they work, and the advantages and disadvantages of using them.
What is a Limit Order?
A limit order is a type of order to buy or sell a stock at a specific price or better. When you place a limit order, you are setting a limit on the maximum price you are willing to pay to buy a stock or the minimum price you are willing to accept to sell a stock. Once you place a limit order, your broker will only execute the trade if the stock’s market price reaches your specified price or better.
Limit orders are different from market orders, which are orders to buy or sell a stock at the best available price at the time the order is placed. When you place a market order, you are willing to pay whatever price the stock is currently trading at in order to execute the trade.
How Does a Limit Order Work?
Let’s say you want to buy shares of XYZ stock, which is currently trading at $50 per share. You believe that the stock is undervalued and would like to buy it if the price drops to $45 per share. To do this, you would place a limit order to buy XYZ at $45 per share.
If the stock’s price drops to $45 per share or below, your broker will execute the trade and buy the stock for you at $45 per share. If the stock’s price does not reach $45 per share, your order will not be filled, and you will not buy the stock.
The same principle applies if you want to sell shares of a stock. Let’s say you own shares of XYZ stock that you bought at $60 per share, and you want to sell them if the stock’s price rises to $70 per share. You would place a limit order to sell XYZ at $70 per share.
If the stock’s price rises to $70 per share or higher, your broker will execute the trade and sell your shares for you at $70 per share. If the stock’s price does not reach $70 per share, your order will not be filled, and you will continue to hold onto your shares.
Advantages of Using Limit Orders
One of the biggest advantages of using limit orders is that they allow you to have more control over the price at which you buy or sell a stock. When you place a limit order, you know exactly what price you will pay or receive if the trade is executed.
Limit orders can also help you avoid making emotional decisions based on short-term price fluctuations. For example, if you place a limit order to buy a stock at a specific price and the stock’s price drops below that level, you will still buy the stock at the lower price. This can help you avoid the temptation to panic and sell the stock at a loss.
Limit orders can also be useful if you are trading a volatile stock or if you are trading during after-hours trading. By setting a specific price for your order, you can avoid getting caught up in the volatility of the market or the potential for wide bid-ask spreads during after-hours trading.
Disadvantages of Using Limit Orders
While there are several advantages to using limit orders, there are also some disadvantages to keep in mind. One of the biggest disadvantages is that there is no guarantee that your order will be filled. If the stock’s price does not reach your specified price, your order will not be executed, and you may miss out on a potential trade.