When you are buying or selling stocks from the secondary market, you have the option to place different trading order types to get the best execution price. It’s used in stock market to control the buying and selling price of stocks. In this article, we will be discussing what is limit order and how to use limit orders while buying and selling stocks.
What is a limit order in stock market
While buying or selling stocks from the market, you can fix a maximum value per share to buy or minimum value per share to sell. If you set this price to your stocks, your offer to buy or sell will be referred as a limit order. Market will consider that you are willing to buy or sell your common stock, but only when you reached your price. This means, you can set a limit on the amount per share you are willing to pay for buying a stock and the value per share you are willing to get for selling a stock.
How price gets executed
A limit order is basically an instruction by the broker to buy or sell a stock at a specified price. The specified amount can be different or same as market value. If you have set the best value, your offer may go to the top of the list for execution or else it will get in line with others waiting for the turn. Based on the market value per share, your limit order may works its way to the top if it finds a buyer.
Assume for a moment, that the stock of a company XYZ limited is expected to fall and you as an investor is interested to buy it. In such a case, you can place a limit order to buy the stock at a lower value than the present current market value. By doing so, your offer will get executed if market value per share falls to your specified value and there is a buyer at that level. If the price doesn’t fall to your specified value, then it will not get executed and the limit order will be cancelled at the end of the day. Similarly, one can also place a limit order for selling a stock.
Example
Suppose you want to buy 100 shares of XYZ limited at a price of Rs 25 per share. This means, Rs 25 is the maximum amount you would like to pay. In this case, you can place a limit buy order for 100 shares of XYZ limited at a fixed price of Rs 25. This type of offer tells the market that under no circumstances you are willing to pay more than Rs 2,500 for buying the stock. This means if a seller wants to sell 100 shares of XYZ limited at Rs 25 or at a lesser price per share, then your limit buy order will get executed and you will get 100 shares of XYZ limited.
Similarly, if you have placed a limit sell order for 100 shares of XYZ limited at a value of Rs 25 per share, then it means that your offer will not be executed for a price less than Rs 25 per share. Your stock will be sold only when your order finds a buyer for a price of Rs 25 per share or more. This means, if market value is higher than the value you fixed, you will be receiving more than your expectations.
If you set a buy price too low than your market value per share, then chances are that it will never get executed. You should learn how to set your limit orders to get maximum profit. Similarly if you set a sell price too high than the present market value, then chances are that you will not be able to sell your stocks
In a highly volatile market, you have to take extra caution while placing a limit buy or sell order as it may cause you to lose additional profit. It provides a discipline to traders as the buying and selling price is fixed and your offer will be filled only when you get your price or better.
One of the biggest advantages of placing a limit order is that investors get a chance to buy or sell shares at their expected price instead of buying at a market price.
Also Read:
- What is intrinsic value of a stock and how it differs from market value
- Difference between growth and value investing
- How to find out overvaluation or undervaluation of a stock by using P/E ratio
