Limit Order, Explained

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When placing a buy or sell order for a stock or ETF, I'm typically prompted to indicate whether my order is a limit or market one. What's the difference and why does it matter?

Basic Definition of a Limit Order

A limit order is one that is limited by price. I can decide how much I'll pay to buy a stock or how little I'll accept to sell a stock.

When setting a limit on a trade, I'm able to specify my price. However, there's no guarantee that the trade will take place. There must be someone willing to sell shares at my limit price (or lower) or buy shares at my limit price (or higher). I can place the order but it may or may not be executed.

In contrast, a market order is executed at the market price as long as there is a market for the security (enough people interested in buying and selling shares).

How to Place a Limit Order

When initiating a buy or sell order within my brokerage account, I should have the opportunity to specify whether I want to place a limit order or a market order.

To place a limit order, select “limit” when prompted (I may have more choices but for now, let's look at the basics). Next, enter the limit price, which is the price I'm willing to trade a certain security.

In some cases, depending on my brokerage account's interface, the limit price may be populated with the going market price — and I can either accept this price or enter my price.

Next, I should be able to specify the time frame of the limit order. Again, the automatic or default setting varies by broker. Generally, I'll choose to place an order good for the day (only) or one that stands for the next 60 days unless I cancel the order (GTC or good until cancelled).

Circumstances that Don't Allow Use of a Limit Order

There are many circumstances in which I can't specify a limit price when investing. These include:

  • mutual funds:
    These are priced at the end of each trading day and I must accept the price if I want to buy or sell a mutual fund; see Fidelity's explanation of how mutual funds are traded
  • robo-advisory investments: when I invest with an investment advisor and a robo-advisor in particular (such as Betterment), I authorize the advisory firm to make investments on my behalf; typically, I can't place limit orders
  • specialty brokers: some brokers that allow investors to buy fractional shares for deeply discounted fees don't allow limit orders because orders are batched (consolidated) and traded together
  • automatically reinvested dividends: automatically reinvested dividends purchase shares of the original security at a market rate or market-type rate (such as an average rate), rather than a limit price

Even though I can't place a limit order (and specify the price) with these types of transactions, they have their advantages. For example, I may be able to avoid trading fees with no-transaction-fee mutual funds, robo investments, and dividend reinvestment programs. In addition, my focus can be on making regular investments rather than snagging a specific price.

Pros and Cons of Limit Orders

If I have the choice between a limit order and a market order, I like being able to specify the price I am willing to pay for shares of a stock and the price I'm willing to sell shares. Using limit prices has allowed me to be more disciplined in buying and selling a security. If prices are volatile, I can control how much I'll end up paying (or receiving) for shares.

But I have missed snapping up bargains or selling at a good (but not perfect) price because of my limit prices. In these situations — based on what I perceived to be trading direction — I lowered my limit price when buying (or raised my limit when selling) in order to get a better price than my valuation indicated. (I'll admit to having a competitive streak that strikes at inopportune times.) In a few cases, my limit price prevented my trade from being executed.

The type of scenario involving limit orders that I just described is mentioned in an article published on The Motley Fool:

Sometimes you just don't get into — [or] out of — the stock you wanted because your desired price didn't materialize in time. You can always place a new limit order, though, or switch to a market order. For those who really wanted to buy a stock as it began or continued a long ascent, limit orders have proven regrettable.

In some cases, only part of my order may be executed as only a certain number of shares were available at the price specified. Further, a limit order may cost more than a market order.

Still, the limit order can protect me from the capriciousness of market volatility or an unusual happening (like a flash crash).

Whether I place a limit order or a market order is a personal decision. But knowing the difference between the two main types of orders and when they're available may help me make better investing decisions.

Do you prefer market or limit orders?

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