Definition
A limit order is an order to buy or sell a security at a specific price or better. For buy limit orders, this means the order will only be executed at the limit price or lower, while for sell limit orders, the trade will occur at the limit price or higher. Limit orders are used to enter or exit a position at a specified, favorable price.
Examples
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Buy Limit Order: An investor wants to purchase shares of XYZ Corporation but only if the price drops to $50 or below. The buy limit order ensures that they do not pay more than $50 per share.
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Sell Limit Order: An investor wishes to sell shares of XYZ Corporation but only if the price reaches $75 or higher. The sell limit order ensures that the shares are not sold for less than $75.
Frequently Asked Questions (FAQs)
What is the main advantage of a limit order?
The main advantage is price certainty. The trader can specify the price at which they are willing to buy or sell, ensuring they do not trade at a less favorable price.
Are limit orders guaranteed to be executed?
No, limit orders are not guaranteed to be executed. If the market price never reaches the limit price, the order will remain unfulfilled.
How long do limit orders last?
Limit orders can be set to expire at the end of the trading day (Good for Day) or can remain active until canceled (Good ‘Til Cancelled).
Can a limit order be partially filled?
Yes, a limit order can be partially filled if only a portion of the order can be executed at the limit price or better.
Is a limit order the same as a stop order?
No, a limit order requires the trade to be executed at a specific price or better, whereas a stop order is activated when the market reaches a specified stop price and becomes a market order.
Market Order
A market order is an order to buy or sell immediately at the best available current price, offering speed but no price guarantee.
Stop Order
A stop order is an order to buy or sell a security once it reaches a specified price, known as the stop price. Once triggered, it becomes a market order.
Stop-Limit Order
A stop-limit order combines the features of a stop order and a limit order, activating the limit order once the stop price is reached.
Online References
Suggested Books for Further Studies
- “The Intelligent Investor” by Benjamin Graham
- “Flash Boys: A Wall Street Revolt” by Michael Lewis
- “A Random Walk Down Wall Street” by Burton G. Malkiel
Fundamentals of Limit Orders: Securities Trading Basics Quiz
### What is a limit order?
- [ ] An order to buy or sell immediately at the current market price.
- [ ] An order to buy or sell a security at the end of the trading day.
- [x] An order to buy or sell a security at a specific price or better.
- [ ] An order to cancel a previous trade.
> **Explanation:** A limit order is an instruction to buy or sell a security at a specific price or better. This ensures execution only at the specified price or more favorable terms.
### Can a limit order be executed if the market price never reaches the limit price?
- [ ] Yes, it will be executed at the best available price.
- [x] No, it will not be executed.
- [ ] Only partially.
- [ ] It depends on the broker.
> **Explanation:** A limit order will not be executed if the market price does not reach the limit price. It ensures that you do not trade at a less favorable price.
### What guarantees do limit orders provide to traders?
- [ ] Execution within 10 minutes.
- [ ] Guaranteed execution at any price.
- [x] Price certainty.
- [ ] No guarantees whatsoever.
> **Explanation:** Limit orders provide price certainty, meaning that the trade will be executed only at the specified price or better.
### Can a limit order expire?
- [x] Yes, if set as Good for Day or until canceled.
- [ ] No, they remain open indefinitely.
- [ ] Only under specific conditions.
- [ ] Rarely.
> **Explanation:** Limit orders can be set to expire at the end of the trading day (Good for Day) or remain active until manually canceled (Good 'Til Cancelled).
### What happens when a limit order is partially filled?
- [ ] The rest of the order is automatically canceled.
- [x] The remaining order stays open until the limit price is met.
- [ ] The entire order must be canceled and re-entered.
- [ ] Only market orders can be partially filled.
> **Explanation:** The remaining portion of the partially filled limit order will remain open and could get executed later if the limit price is met.
### What kind of price restrictions does a buy limit order imply?
- [x] The order will be executed at the limit price or lower.
- [ ] The order will be executed at any price above the limit.
- [ ] The order will be executed exactly at the limit price.
- [ ] There are no price restrictions.
> **Explanation:** A buy limit order ensures execution at the limit price or lower, guaranteeing favorable pricing for the buyer.
### What is the significant difference between a limit order and a market order?
- [ ] Limit orders execute instantly, market orders do not.
- [x] Limit orders specify the price, market orders do not.
- [ ] Market orders have price limits, limit orders do not.
- [ ] There's no difference.
> **Explanation:** Limit orders allow traders to specify the price at which they are willing to execute a trade, whereas market orders execute immediately at the current market price without price specification.
### When does a sell limit order execute?
- [ ] When the market reaches any price above the current price.
- [ ] When the market reaches any price below the set price.
- [x] When the market reaches the limit price or higher.
- [ ] Whenever the trader requests.
> **Explanation:** A sell limit order is executed when the market price meets or exceeds the specified limit price, ensuring the seller does not receive a lower price.
### Can limit orders be used in volatile markets?
- [x] Yes, they are ideal for volatile markets.
- [ ] No, they are only suitable for stable markets.
- [ ] It depends on the security being traded.
- [ ] Rarely.
> **Explanation:** Limit orders are ideal in volatile markets as they allow traders to set specific prices to avoid adverse effects of rapid price changes.
### What type of order would you use to ensure you buy a stock only if it falls to a specific price?
- [ ] A market order.
- [x] A buy limit order.
- [ ] A stop order.
- [ ] A sell limit order.
> **Explanation:** A buy limit order ensures that you purchase the stock only if it declines to a specific price, providing price control in volatile market environments.
Thank you for exploring this comprehensive guide to limit orders. This detailed explanation and the accompanying quiz should aid in understanding the intricacies of securities trading. Keep advancing your financial acumen!
