Limit Order

Definition

A limit order is a type of order placed with a securities exchange to buy or sell a financial instrument at a specified price or better. It allows the trader to have more control over the price at which the transaction is executed, compared to a market order.

5 Must Know Facts For Your Next Test

1. Limit orders are used to control the price at which a trade is executed, as opposed to market orders which execute at the current market price.
2. Limit orders can be set to buy at or below a specified price (limit buy order) or sell at or above a specified price (limit sell order).
3. Limit orders are typically used when the trader believes the current market price is not favorable and they want to wait for a better price to execute the trade.
4. Limit orders are placed in the order book and are executed when the market price matches the limit price or becomes more favorable for the trader.
5. Limit orders may not be executed if the market price never reaches the specified limit price, unlike market orders which are guaranteed to execute at the current market price.

Review Questions

• Explain how a limit order differs from a market order in the context of buying and selling securities.
  • A limit order allows the trader to specify the maximum price they are willing to pay to buy a security or the minimum price they are willing to accept to sell a security. This gives the trader more control over the execution price compared to a market order, which executes at the current best available price in the market. Limit orders are used when the trader believes the current market price is not favorable and they want to wait for a better price to execute the trade, while market orders are used when the trader prioritizes immediate execution over price control.
• Describe the role of the order book in the execution of limit orders.
  • The order book is a record of all unexecuted buy and sell orders for a particular financial instrument, organized by price level. Limit orders are placed in the order book, and they are executed when the market price matches the limit price or becomes more favorable for the trader. The order book allows the exchange to match buy and sell orders at the best available prices, facilitating the execution of limit orders. The position of a limit order in the order book, along with the volume of orders at each price level, can provide valuable information to traders about the market's supply and demand dynamics.
• Evaluate the potential advantages and disadvantages of using a limit order compared to a market order when buying or selling securities.
  • The primary advantage of using a limit order is the ability to control the execution price, which can be beneficial when the market price is volatile or unfavorable. Limit orders help traders avoid buying at prices that are too high or selling at prices that are too low. However, the potential downside is that a limit order may not be executed if the market price never reaches the specified limit price, unlike a market order which is guaranteed to execute at the current best available price. This means that limit orders carry the risk of non-execution, while market orders carry the risk of potentially less favorable pricing. Traders must weigh these tradeoffs and choose the order type that best aligns with their investment objectives and risk tolerance.

Related terms

Market Order: A market order is an order to buy or sell a financial instrument immediately at the best available current price.

Stop Order: A stop order is an order to buy or sell a financial instrument once the price reaches a specified level, known as the stop price.

Order Book: The order book is a record of unexecuted buy and sell orders for a particular financial instrument, organized by price level.