What are Orders: Market Orders (Part 2)
It is recommended that you read What are Orders? (Part 1) to understand the concept/definitions of orders before reading this post.
What is a Limit Order?
This type of order is used by investors who have preference for a specific price when buying or selling a stock. While the investor has more control over what price they would like to purchase/sell the security for, the order may not be executed.
The length of the limit orders is dependent on the patience/decision of the investor. If the investor believes that they can buy/sell the security at the price they want in the given day, they will place a day order. If the investor believes that it will take longer for their limit price to be reached, they will place a good-till-cancelled order (GTC).
Advantages of Limit Orders:
The security can be bought/sold at the price selected by the investor or better, giving the investor more control on the price.
Unlike market orders, limit orders can be modified/cancelled so as long as the order has not been executed.
Disadvantage of Limit Orders:
Limit orders may not execute right away, in fact, if the security consistently moves in the opposite direction from the desired price, the order may not be executed at all.
Example of a Limit Order
Consider an investor that owns a stock that is currently worth $100. With a bid price of $98 and an ask price of $102. The investor decides to place a limit order to sell the stock at a price of $110 about $8 higher than the lowest price offered by the sellers. No bidder will be willing to buy the stock for $110 if there are prices below that, therefore the order will not be executed right away. The next day, a positive earnings report boosts the stock’s value to the investor’s limit price. The order is then executed and the investor sells that stock for the desired price of $110. How much profit the investor made is dependent on the price that he had initially purchased the stock for.
However, assume that the stock’s earnings report is negative and instead drop’s the stock’s value to $90. The investor has 3 options when dealing with this new information.
Keep the order to the sell the stock at $110 in hopes that the stock’s value with rise in the future
Modify the order to lower the limit selling price to make selling the stock more realistic. The investor will likely lower their price down to between $90 – $100.
Cancel the order completely and continue holding onto the stock. Then place a new order when a similar or better opportunity to sell the stock arises.
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