When you’re getting started investing there are many terms you may be unfamiliar with or practices you may not be too keen on. How are you sure when you put in a “buy” order on a security that the sale is not going to go through for far more than you’d wanted it to? This is the importance of knowing the difference between a “market order” and a “buy limit order.” But what are the differences and just what does a “buy limit order” mean? How are they executed?
Buy limit orders are orders to purchase a security at or below a certain price. Investopedia (1) reminds us that buy limit orders allow “…traders and investors to specify the price that they are willing to pay for a security, such as a stock.” When you are setting up your order you are telling the brokerage house that you will pay “X-price;” no more. “By using a buy limit order, the investor is guaranteed to pay that price or better” guaranteeing that you will not be shirked for far more than you’d wanted to pay.
Limit orders are far preferable to the open “market order” especially on low volume stocks. Market orders are fine on heavily traded stocks as you’re likely to get around the price you saw when you executed the order. But for low-volume stocks, buy limit orders are far preferable. Also if you’ve been tracking a stock and you’ve watched it bounce between two points for some time, you may be able to catch the bottom and get out at the top by placing buy and sell limit orders.
That’s great, you may say, now how do I place these orders? Well that depends on how you typically execute orders. If you’re going to talk with someone on the phone about an order than you have to specify that you’d like it to be a buy limit order for whatever price you want and then the operator will place the trade for you.
If you’re online investing then you can set up the parameters for the buy limit order from the portion of your broker’s homepage dedicated to your account. When you’re placing the trade it will say “market order” or “limit order” and you enter the type of trade you’d like. If you do select limit order, a second window should pop up asking the price you’d like to set for the threshold for you to buy this security. If your account is properly funded, the next trade which falls at or below your threshold will find your order executed.
The only downside to the buy limit order is that even if you place this order during the trading day, there is no guarantee that the order will be executed. “While the price is guaranteed, the filling of the order is not. In other words, if the specified price is never met, the order will not be filled and the investor may miss out on the trading opportunity.” However it’s better to miss out on the upside than face the potential downside of buying in on a market order at a peak and being left holding stock which is then depressed and may never recover.
Source:
(1) http://www.investopedia.com/terms/b/buy-limit-order.asp
