Limit Order

Key Learning Points

• A limit order is an instruction to trade that guarantees execution at a pre-determined price or better
• Although limit orders guarantee an execution price, there is no certainty of execution
• Unlike market orders that are aimed at speed of execution, limit orders prioritise price precision
• Limit orders can help remove emotions from trading and would prevent from making irrational decisions during unusual market conditions

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How Limit Orders Work

One of the advantages of limit orders is that they are automated, meaning that once set up traders would not need to constantly monitor the price of an asset in order to trade. This feature is particularly useful during periods of higher market volatility when prices are moving fast and may not allow enough time for a trade to be put manually at the desired by the trader price. However, it should be noted that limit orders do not guarantee that the order will be executed immediately (or even at all).

As a rule of thumb:

• If a trader is going long, i.e. buying, the limit order will be below the current price
• If they are going short, meaning that they are selling, the limit-entry order will be above the current price

Limit Entry Order

Going Long

Going Short

Limit orders are also used in currency (i.e. Foreign Exchange or FX) trading. It works on the same principle where the trader sets the rate at which they want to exchange money (along with an expiry date, for example, 6 months) from one currency to another. Should  that rate become available, the exchange will happen automatically.

Limit Order Example

The below chart shoes Nvidia’s price performance over the past six months.

On the 19th of August, a trader is looking to purchase the stock but thinks the current price of $130 per share is too high. He sets his target price to be 15% lower than the current market price, which is $110.5. The order will execute only if this (or lower) price is reached. During the trading session on the 30th of August the company’s share price dropped to $110.3 and the order was executed.

After the purchase, the trader also set a limit order to sell at 25% higher than the buy price of $110.5, which is $138.1 (or higher). During trading the intra-day trading on the 15th of September, Nvidia’s share price reached $138.5 and the order was executed.

Limit Orders vs. Market Orders

Limit orders and market orders are the two main execution types that are available for the trader to choose from when placing an order to trade. “At market” is a type of instruction that is expected to be executed as quickly as possible at the current market price, whether “at limit” sets the minimum and/or maximum price at which the trader is willing the transaction to take place. Also, the two differ in their purpose for use – with market orders, the most important is the speed of execution, while limit orders primarily focus on price.

From a technical perspective, market orders can only be executed during the standard trading hours (for example, the core trading hours on the  are between 9.30am and 4pm). Conversely, in addition to the regular market hours, limit orders can also be placed during pre- and after-hours trading but will expire at the end of the session if they are not filled or cancelled. It is important to note that liquidity during pre-market and after-hours trading sessions is lower compared to the standard hours and any limits should be carefully considered.

Nevertheless, this is not applicable to the standard trading session and will allow the trader to determine the duration of the instruction.

Below are some of the key order types and their definition.

Benefits and Risks of a Limit Order

There are some key benefits and risks related to limit orders that we list below.

Benefits

• Price Control: determining a specific price for buying or selling, ensures that traders do not pay more or sell for less than they would accept.
• Strategic Execution: allowing traders to target favourable price levels, making them suitable for implementing strategic plans.
• Reduced Emotional Trading: limit orders allow traders to avoid making impulsive decisions driven by market fluctuations.

Risks

• Non-Execution: should the security does not reach the limit price, the order remains unfulfilled, which could potentially lead to missing opportunities.
• Partial Fills: sometimes only part of the order may execute, leaving the trader with an incomplete position.
• Market Reversal: markets can move quickly, and if a higher volatility was not factored in when estimating the limit price, during periods of market turbulence limit orders can get executed, leading to potential losses or reduced profits.

What is the Difference Between a Stop Order and a Limit Order?

Although both stop and limit orders are instructions to trade, they have been designed to serve different purposes. A limit order requires for a specific price to be set at which a trader wants to buy or sell, ensuring execution occurs only at that price or better. It is aimed at allowing traders to target favourable entry or exit prices. On the other hand, stop orders are often used to limit losses or lock in profits. A stop order is triggered only when the market price reaches a specific level, known as the stop price. Once triggered, it becomes a market order. We also have dedicated blogs on Stop-Limit and Stop-Loss order, where we explore them in more depth.

Conclusion

To sum up, limit orders are useful tool for traders seeking a strict price control and discipline in their transactions. They also allow for strategic planning by automatically entering or exiting positions without constant monitoring the markets, which can be part of a risk management strategy and/or enhance efficiency by optimising profits. However, traders should carefully consider market fluctuations, liquidity and time horizon when setting up their limit prices in order to maximise their benefits.