Limit Order

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Limit Order is one of the many order types a normal trader uses to place his/her trades in the stock market.

But, what are these trade orders then?

Well, trade orders are the instructions given to the broker as to when and at what price are the securities to be purchased. These orders can be of various types, depending upon the requirements and the restrictions of the trader and they can be conditional or unconditional.

One of the types of trading orders is Limit Order.

What is a Limit Order?

Limit Order is a conditional order which instructs the stockbroker to buy or sell the security at a specific price or a price better than the specified price.

A buy limit order gets executed only when the security is at a specified price or a price lower than that, and a sell limit order is executed only when the security is at the specified limit price or a price higher than that.

Unlike the market order, the purchase or sale will go through only when the specified price is reached in the market.

For example, a trader wants to buy the shares of IBM only at ₹160 or lower.

In that case, he will place a limit order with buy limit price as ₹160 and the order will be executed only when the price of IBM share is at ₹160 or lower than that (in case the stock market opens at a price lower than the specified limit).

As a downside, a limit order may not get filled immediately or at all, as the price specified may or may not be reached; however, it is an excellent mechanism to control risks.

By using the limit order, a trader can ensure that the securities are not bought at a high price and not sold at a low price.

The risks remain optimised.

Limit orders are of prime importance in intraday trading or in any form of trading which involves high volatility and high risks.

It also ensures that the trader will be able to capture his target buying or selling price if the security gets dealt at that price in the market.

Limit Order Types

Based on the conditions attached to it, the limit order can be of the following types:

  1. All or none order: It is a type of limit order which instructs that all shares will be bought or sold at the same time if the trade is to be executed. The trade will be executed only if the full quantity of shares are available to be executed.
  2. Fill or Kill order: This type of limit orders states that the order must be immediately executed or cancelled.
  3. Limit on open order: Securities will be bought or sold at whatever the opening price of the market is but within a predetermined limit price.
  4. Limit on close order: Securities are bought or sold at the closing price of the market, but with a limit price.
  5. One cancels the other order: It is limit order in which the only one of the two orders is executed, whichever meets the mentioned parameters first and the other is automatically cancelled.

Limit Order Buy

Now, we understand how the limit order works. When we talk about a limit order buy transaction, it basically implies that the trader is setting up a limit order in order to buy a particular investment product at a specific price.

The good part about this type of order is that you will get the stock or commodity or whatever you are looking to buy from the stock market at the desired price.

BUT!

The related bad part about limit order buy is that there are chances that the stock you are interested in, may not reach the price point you have set as part of the limit order and the transaction does not happen at all.

In other words, there is NO guarantee that the order you are looking to get through will actually get through at all.

Thus, this kind of order comes with its bag of potential missed opportunities in a market situation that could have been very lucrative for you if you had chosen a different type of order for that transaction.

Limit Order Buy Example

Let’s take an example to understand this concept.

For instance, if the stock of ABC Corp is currently trading at INR 530 on the stock market and there has been a bit of volatility observed in the stock due to a policy announcement by the current government.

Due to the current nature of the stock, you don’t know whether you should be buying the stock at the price it is currently available or not.

You choose to place a limit order buy at a price point of INR 495 with an assumption that the stock is volatile enough to keep bouncing around this price point.

Now, there are 2 potential outcomes from here:

  1. The stock price hits the price point of INR 495 and the order gets executed for you. When this happens, the number of stocks you had asked for in the order are transferred to your Demat account post a corresponding monetary deduction from your trading account.
  2. The stock price does not hit the price of INR 495 and you don’t get to avail that stock order into your account as part of that order.

In a sense, if it is “okay” for you that the stock does not land into your kitty and you are stringent on the price point you are looking to make the purchase at, then, by all means, go ahead with the limit order buy mode.

However, if you are just trying to get a better “deal” and have actually been looking to invest in that particular stock, then you have to choose the order type accordingly post your analysis.

Limit Order Sell

At the same time, a limit order sell comes into the play when you are looking to exit the trade at a price point of your choice.

In this case, you are selling off a bunch of stocks as part of the trade order and are expecting the price to reach a value from where you can make an exit and get your profits.

Now, as was the case with Limit order buy, here as well there are chances that your order never takes off as the stock does not reach the price point you anticipated it would.

Furthermore, there is a possibility that yes, the stock does reach a price point that you thought it would and the trade passes through handing you the profit you wanted.

But!

The stock continues its rally and gets to a much higher price point and you end up losing out on making some extra profit on your trade as your limit order had already exited you off the trade.

Limit Order Sell Example

Let’s understand this concept as well with the help of an example.

So, taking the same example of ABC corp discussed above, let’s say you had the stock at the price point of INR 495.

And now, the stock is trading at 520. So you are already in profit!

Well, you go ahead and place a limit order and choose the exit price point at INR 530.

Let’s say, the stock breaches that mark and thus, you end up exiting the trade BUT the stock continues its bullish momentum and reaches price points of IN 550 and beyond.

However, as you have already exited the trade, there is nothing you can do to bring additional profits to your table.

Quite a miss, right?

So, this situation MAY occur when you are using limit order as part of your trading place.

Pros and Cons, huh!

Limit Order Pros and Cons

Talking about the pros and cons, here are some of those listed in relation to limit orders:

Pros Cons
Helps to control risk in a highly volatile market Not guaranteed as the market may not reach the specified entry or exit price
Desired price or better is achieved In less liquid markets, an order may not get executed
Makes the trader more disciplined Does not get executed immediately, less time-sensitive
Does not make the trader overpay for a security

Thus, in volatile market conditions, like intraday trading, it is always suggested to trade using limit orders.

This puts a check on the price at which the trader enters or exits a trade, and thus the trader is able to determine his own entry and exit positions based on his research and technical analysis.

It helps the trader evade heavy risks and controls the losses that could have occurred in case the trader entered the market as any available current market price.

Limit Order Book

So, as the name suggests, the limit order book entails the records of all the entered limit orders that need to be executed on the index.

This list of orders is given the top priority as compared to other order types for the simple reason that there are specific pre-conditions linked to the orders in this list.

There is a specific guarantee associated with the listed limit orders in this book.

Limit Order Vs Market Order

There are a few subtle areas where the order types i.e. Limit order and market order have their differences.

Here is a quick glance:

  1. A limit order has specific price based conditions while the market order gets executed as soon as it is placed.
  2. You set a buy or sell price while you enter into a limit order, however, the current market price is the point used for the market order to get executed.
  3. A limit order attracts a few charges at times, while a market order is treated as a generic stock market order and you are charged with brokerage and few other related costs.

Like mentioned above, different order types have their own set of pros and cons. Thus, you need to be totally sure of what you are getting into before you end up placing your trade.

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