Limit order explained
What is a limit order?
Limit orders enable traders to specify exactly when they would like to buy or sell shares – reducing the chance that nasty surprises will eat into their profits or cost them an opportunity.
First up, you have buy limit orders. Let’s say that a trader really wants to invest in McDonald’s shares, but they believe that the current price of $207 is too high. They can establish a buy limit order for $200 that means their broker will automatically seek to purchase shares if they fall to this level. It’s even possible that a trader might end up paying even less than this. If McDonald’s closes a trading day at $201 but opens the next session at $190, the shares would be purchased at this price – representing a saving of $10 per share.
As you’d expect, sell limit orders are used whenever an investor is prepared to cash in their shares. Let’s imagine that another trader is eager to dispose of their McDonald’s shares, but believes that self-same price of $207 is too low. They can set a limit order that ensures their shares are only sold when prices hit $220 or better.
It’s crucial to bear in mind that there’s no guarantee that a limit order will successfully be executed. For buyers, there has to be someone who is willing to sell to them at the specified price – and while sellers can dream of raking in the cash with a high price for their shares, it will only become a reality if someone is interested in the offer.
Limit orders are not to be confused with market orders, where brokers are asked to buy or sell shares as soon as possible. Market orders are perfectly adequate if you’re more or less satisfied with the prices that are currently available. Traders will tend to use limit orders when they’re thinking long-term – they’d like to own shares in McDonald’s, but they believe that the price is a little bit overvalued right now.