A limit order is an instruction to a stock broker or brokerage service to either buy or sell a stock at a specified price. If the limit order is for a stock purchase, the price can be lower than the specified price for the trade to occur. If the limit order is for a stock sale, the price can be higher. This is different from a market order that is an instruction to buy or sell a stock at the current market price. The purpose of a limit order is to restrict the risk of a sudden price fluctuation while investing in the stock market.
Significance
Investors use buy limit orders to avoid spending more than they want for a fast-moving stock. With a market order, you can order a buy only to find that the stock price skyrocketed in the lag time between your order and the actual execution of the buy. This happens quite often with initial public offerings. Buy limit orders also are used by investors looking for a good deal on a stock. The investor places a limit order for the desired price and waits for the price to drop. Investors use sell limit orders to prevent their stocks from selling below a desired price.
How It Works
To place a limit order, you must give a specific instruction to your stockbroker or stock trading service. The limit order must specify the stock to buy or sell, the number of shares, the limit price of the stock and when to cancel the order if the limit price is not reached. For a buy limit order, the stockbroker or brokerage service will purchase the stock when the price falls to or below the limit price. For a sell limit order, the stockbroker or brokerage service will sell the stock when the price rises to or above the limit price.
Number of Shares
Your stockbroker or brokerage service will always try to buy or sell the specified number of shares in your limit order, but this is not always possible, especially if your limit order is for a large number of shares. Investors can prevent their limit order from being split by designating it as a "fill or kill" order. This requires all the shares in your limit order to be bought or sold, or the limit order is canceled. You would then have to place your limit order again if you want the same terms. Investors also can designate limit orders as "all or none." This prevents the limit order from being split but keeps the limit order active in case the stock price reaches your limit order price again. Keeping your entire order intact saves on fees. A split order can be treated as two different transactions.
Misconceptions
Just because you place a limit order to buy or sell a stock at a specified price, it does not mean you will get the stock at that price. It may simply never get to that price, so your order sits unfilled indefinitely. If the stock is extremely volatile, the price can fluctuate so quickly that there is not enough time to fill your limit order before the price returns to an unacceptable level.
Considerations
Stockbrokers and brokerage services usually charge higher fees for limit orders than market orders. This is because more attention and time must be spent on a limit order than an ordinary market order.