A limit order is a type of order to buy or sell a security at either a predefined price or better than that. For buy limit orders, the order will be executed only at the limit price or a lower one, while for sell limit orders, the order will be executed only at the limit price or higher. This gives merchants more control over the prices at which they transact.
By placing a buy limit order, the investor ensures that the price will not rise above the limit. Limit orders will not be executed until the security's price matches the order criteria. It's possible that the investor will miss out on a trading opportunity if the asset's price doesn't reach the predetermined point in time.
In contrast, a market order executes a trade at the current market price without specifying a price limit.
How does limit order work?
The use of a predetermined price to purchase or sell securities is a limit order. For example, if a dealer seeks to buy XYZ's shares at ₹14.50, the stock is only bought at the rate of ₹14.50 a share.
If the trader wishes to sell XYZ shares with an ₹14.50 limit, the trader shall not sell any shares until the prices have risen to ₹14.50 or higher. The investor is guaranteed to pay the purchase price or higher by executing a purchase limit order, but the order is not guaranteed.
A limit order allows a trader more control over the execution of a security price, particularly if it is scared of utilising a market order during heightened volatility.
There have been several situations where limit orders were used, for example when an inventory rises or falls very rapidly, and a trader feared that a faulty order would fill. Furthermore, if a trader does not closely monitor the price movements of stock but is still willing to buy or sell at a predetermined price, a limit order can be used.
A portfolio manager wants to purchase the stock of ABC but believes that its present estimate of ₹325 per share is overpriced and would want to buy the stock only if it falls below ₹250. The manager tells their dealer for the purchase of 10,000 ABC shares should the price be lower than ₹250.
The trader then orders to buy 10,000 shares with a limit of ₹250. If the stock falls below the price, the trader may start purchasing the stock. The order remains active till the stock is within the limit of PM or until the transaction is cancelled.
In addition, the portfolio manager wants to sell the shares of XYZ but believes that its current price of ₹1,350 is too low. He would be interested to sell his shareholding if the price hits at least ₹2,500. The trader will, in this case, place the order to sell 5,000 shares with a limit of ₹2,500.
Limit orders V/S Market orders
In order to buy or sell a stock, an investor has two basic price-related execution options: placing the order on the market or at a limit. Market orders are intended to carry out transactions at current or market prices as rapidly as possible. Conversely, you are willing to purchase or sell a limit order that sets the maximum or minimum price.
The purchase of the stock is analogous to the purchase of an automobile. You can pay a sticker price for the dealer and acquire the car with a car. Or, if the dealer does not meet your pricing, you can haggle the price and refuse to finish it. Similarly, the stock market is likely to work.
Advantage of limit order
The greatest advantage of the limit order is that your price will be specified and that the order will be completed if the stock hits that price. Sometimes the broker even places a better price for your order.
Disadvantage of limit order
It is not guaranteed that you will be able to trade stock. If the inventory does not reach the price limit, the deal will not be carried out. Although you may decide the price at which you wish to buy or sell, the demand or supply for the order may not be enough. For unpopular and illiquid stocks, this scenario is more likely to happen.
So, we can summarise that a limit order is placing a limit to buy or sell a security at a predefined maximum or minimum price, respectively.