What is a Limit Order?

A limit order is an order to buy or sell a security at a specific price. For example, you might want to place a limit order bid to buy 100 shares of company X at $50 per share when the market price is at $60 bid, expecting that the price will decline at $50 in the near future. By entering a limit order rather than a market order, which would buy at the best current price and not at the desired price, you eliminate the possibility to buy at $60 and then suffer immediate losses if the stock drops later in the day or the weeks ahead.

Limit orders are placed to avoid buying or selling a stock at a price higher or lower than desired. A purchase limit order is executed only at the limit price or lower, while a sell limit order is executed only at the limit price or higher. When you contact your broker to place a limit order, you need also to indicate how long the limit order will be outstanding. Limit orders can be instantaneous using the terms "fill" meaning fill the order instantly or "kill" meaning cancel it, or they can be outstanding for a trading day, week or month. They can also be open-ended or good until cancelled. Typically, brokers give the limit order to market specialists, who put it in a limit-order book and act as the broker's representative. When the market price reaches the limit order, the specialist executes the order and informs the broker. The specialist gets a small commission for rendering this service.

A limit order gives you the prospect to control the maximum or minimum price at which your money is spent or earned. For example, if you specify the limit price at $50 and a share limit of 100 shares, then you know that the most you will spend or gain is $5,000. So, a limit order actually protects you against significant loss of money.

However, limit orders are not guaranteed to be effective if the market price never reaches the limit order level. In a way, limit orders lock investors in to a certain price. Even if you have the insight that the market price will reach your limit order level, still if it doesn't, you are obliged to keep that stock until you can get that limit order lifted.

Generally, limit orders are mostly used on a stock exchange than in over-the-counter markets. The main reason for this is the quicker rate at which market prices fluctuate and overall pace at which prices rise or fall on exchanges. However, because of this intense nature of the up or down swings in price on exchanges, a limit order might not be executed.