Why use Limit Orders when buying Stocks?
What is a Limit Order?
Suppose you see the price of a stock on the market listed as $24. Then you place an order to buy 20 shares, except, after the order goes through you notice you paid $24.72. That’s 3% more than expected, what happened?
This sort of thing is prevented if you use what is called a Limit Order. Today I’ll show you why you need to understand limit orders and why placing a simple Market order may not be your best bet. I’ll explain how these two are different.
How do Limit Orders Work?
Limit Orders specify an exact specific price you are willing to pay. For example, if you place a limit order for $24.00 and the market price moves to $24.20, then, your order doesn’t get filled. A Limit order is ONLY filled if the price is $24 or lower (It also gets filled if the price goes lower).
A limit order can sometimes get you a better deal. For instance, going back to my example where the market price is $24.00. Suppose you place a limit order for $23. There is a possibility your order gets filled at $23 instead of the original $24 you thought you’d have to pay. There may be a seller on the other side willing to let his shares go for $23, despite market price currently resting at $24.
I have placed limit orders a dollar or more below market price and had them filled. Why pay more than you have to? Why pay the asking price if you can get a better deal? Now, of course, the disadvantage of this is you may not get in on your stock at all if no one wants to sell it lower. This is why it’s good to set realistic LIMIT ORDERS; don’t set a limit order 15% from the current price and hope your order gets filled by days end.
Another reason to use LIMIT ORDERS is due to what’s called spread, in particular, if you buy small-cap stocks or stocks with lower volume, the spread can be greater.
What is Spread?
Spread is simply the difference between the BID price and the ASKING price of the market maker. With a market order, you could lose over 1% immediately if the spread is high. You could pay $24.00 for a stock that you could only get $23.50 for immediately after buying it (or worse!)
A LIMIT ORDER offers protection from losing big on spreads. If you set the limit order lower than their asking price then you won’t get beat by the market makers with the spread. You are once again setting a limit on what you will pay. There is no surprise here.
I ALWAYS use LIMIT ORDERS, even when buying ETF’s.
Lastly, Limit Orders work for selling stocks as well, but I will cover that and more details about Limit Orders another day. However, please keep limit orders in mind when purchasing stocks. I wished someone had told me this when I first began.
Limit Orders normally last until the end of the trading unless specified. You can do a Good Till Cancelled Order and that is canceled when you cancel it.
As usual, I am not a financial advisor, this doesn’t constitute professional advice. Seek professional advisory before making any investment and always do your own research. This website and blog are for my own entertainment and archival purposes.