Limit order: how does it work?
Limit order: what is it, how long does it take and some examples. Discover more about the definition of limit orders on Fineco's Newsroom.
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Limit order: definition and how does it work
When you buy or sell a share, you can use different types of orders, which are tools that allow you to take advantage of certain conditions. The limit order is one of the most commonly used by traders, allowing them to execute a purchase or sale only if the share reaches a specific price range.
The limit order is a tool mainly used in online trading activities in order to better plan which operations to execute and to optimise the price management of negotiated shares. In this in-depth article, we will look at what buy and sell limit orders are and use some practical examples in order to understand how this tool works.
What is a limit order?
In online trading, you can set up order executions based on your own needs by using tools such as limit orders. They are orders with buy or sell limits that limit trading to certain market conditions. If these conditions are not met, the order is not executed.
Firstly, let’s look at what a sell limit order is, namely, an order with a sell limit. It is a tool that allows you to execute an order only if the price is equal to or higher than the limit price set by the trader. For example, by establishing a price limit of £50, the order is not executed until the asset reaches or exceeds £50.
On the other hand, by setting up a buy limit order, the order is only executed if the price reaches a value equal to or lower than that limit. For example, by establishing a buy limit order of £50, the order is not executed until the price reaches a value of £50 or less.
How sell and buy limit orders work
The use of limit orders allows traders to only execute orders if the price meets certain requirements. To establish the limit order’s price you must use technical analysis by studying graphs with trading indicators to understand the right limit value to assign based on your investment strategy.
Once the limit order has been set, the intermediary only executes the order when it meets certain requirements set by the trader; however, there is no guarantee that the order will actually be executed. This is therefore a request on behalf of the trader that the intermediary attempts to meet if the market conditions allow.
A limit order can be used in various contexts:
- To ensure that you buy or sell an asset within a specific price range
- To better control the price in case of high market volatility
- To reduce risk when prices rise and fall rapidly
- To automate certain trades without having to spend hours in front of your computer screen
Indeed, once you have set up a buy or sell limit order, trading will only be executed under the requested conditions; therefore, you can do other things without having to monitor price trends constantly. Nowadays, many trading platforms allow you to set up limit orders simply and intuitively, making it easier for traders to plan which investments to make.
How long can limit orders be?
Limit orders can have a specified expiration or can be left open. Generally, the intermediary allows the order to stay open for some months, after which time the request is closed and you must make a new buy or sell limit order. However, this time limit is based on the intermediary’s rules, so you must read carefully what time limit is required by them.
Stop order vs limit order
Two types of orders that are apparently similar are limit orders and stop orders; however, they are two different tools. As we saw earlier, a limit order is an order with a buy or sell limit whereby the order is only executed if the price reaches a specified price range (equal to or lower than the price limit for buy limit orders, and equal to or higher than the price limit for sell limit orders).
However, a stop order is an order that is only executed when the price is equal to or higher than the price established by the trader. Also known as stop-loss, this type of order is used to better manage risk, limiting potential losses by closing open positions when the price reaches a certain value.
When choosing between a limit order vs a stop order, you must consider the type of operations that you want to execute, even though both are useful tools for managing price volatility. In particular, there are two differences between these types of orders. A limit order is visible to the market whereas only the intermediary can see a stop order; in fact, it only becomes visible on the market once it is activated.
When a limit order is triggered, the transaction takes place; whereas when a stop order is triggered, an order is activated and only after this the transaction takes place. In any case, to properly control prices in trading operations, it’s important to learn how to use all types of orders as they help you to improve your trade management and optimise your trading performance.
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