What is a Limit Order? Overview, Definition and Strategy

A limit order is the purchase or sale of a security, pre-conditioned upon the trade occurring at an established target price or better. A limit order provides price certainty but there’s no guarantee that your trade will be completed at your target “limit price.” In the event that your limit price is never reached, your trade may expire unfilled. This distinction between price certainty versus execution certainty is the biggest factor that distinguishes limit orders from market orders.

Limit orders are an excellent way to mitigate the risk of price fluctuations in volatile markets. They can even be used to establish price “checkpoints” to purchase and sell a security at your target price, even when you’re not actively monitoring the market.

This guide covers limit orders and is part of a larger collection of guides which cover common order and execution types. Take a look at our table below to see the key features of limit orders and how they stack up against other order types.

Order Type:Limit OrderMarket OrderStop OrderStop-Limit Order
Price CertaintyCertainUncertainUncertainCertain
Execution CertaintyUncertainCertainCertainUncertain

How Do Limit Orders Work?

Limit orders prioritize achieving your target price above else; this stands in stark contrast to market orders which prioritize the quick and timely completion of your trade, even if that means executing at a level that differs from your original target price.

The limit price acts as the hurdle that the security price needs to reach or exceed before the trade can complete. In the event that your limit price isn’t reached within the established timeframe, the limit order will expire uncompleted. 

The risk that your trade remains unfilled is known as “execution risk” and is the primary risk that traders will incur when placing a limit order. This risk is magnified if the market moves further away from your limit price; some traders who were originally a few dollars off from completing their trade may find themselves drifting further and further away, increasing the risk their trade expires unfilled.   

In some cases, it may be a good idea to take the bird in-hand strategy and execute a market order if the trade in question absolutely has to be completed.

Limit orders can be placed as either “buy limit orders” or “sell limit orders” depending on whether you’re seeking to purchase or sell the security. In either case, by placing a limit order, you’re telling the market that you will only accept your set limit price or better.

What is a Buy Limit Order?

From the buyer’s perspective, a buy limit order is an order to purchase an investment at the specified limit price or lower. This ensures that the buyer only completes the trade at their target price or better. 

A trader seeking to purchase a security faces execution risk when using a buy limit order due to the risk that the price of the security may not reach the target limit price before the order expires. This may force them to execute a follow-up trade at a less advantageous price if they still want to complete the trade, further exposing them to market risk.

Example

Buy Limit Order

Shares of Netflix stock (NFLX) are trading at $520 today; you’re a value trader and believe the stock to be cheap at $510, based on your astute analysis. You’d be willing to purchase the security at $510.

Noticing that the market is dropping precipitously today due to negative headlines, you place a buy limit order at $510 and hope the price drops to just around that level (and hopefully not much further!).

The market moves quickly, and you see the price drop in real time from $520, to $518, and eventually $512.50. In the blink of an eye, you see the price hit $509.95 and simultaneously receive a trade confirmation in your inbox. Your buy limit order has completed at $509.95, a full five cents better than your target price!

What is a Sell Limit Order?

From the security owner’s perspective, a sell-limit order is an order to sell an investment at the specified limit price or higher. This ensures that a seller only completes the trade at their target price or better. 

The owner of a security that wishes to sell faces execution risk. This is due to the risk that the price of the security may never reach the target limit price before the order expires. 

In the event the order expires unfilled, the seller may be forced to place a follow-up trade at a less advantageous price if they still wish to sell the security.

Example

Sell Limit Order

You own shares of Netflix stock (NFLX) that are trading at $520 today, based on your rigorous fundamental analysis, you’ve arrived at the conclusion that the stock may be overvalued if it reaches $530. 

Noticing that the market is skyrocketing today due to a positive employment report, you prepare to take profits by placing a sell-limit order with a target limit price of $530.

The market moves quickly, and you see the price spike from $520, to $523, and eventually $529.50. In the blink of an eye, you see the price hit $530.10 and simultaneously receive a trade confirmation in your inbox. Your sell-limit order has completed at $530.10, a full 10 cents better than what you originally targeted, what a take!

When to Use a Limit Order?

A limit order is best suited for trades that need to be executed at a specific price. The key advantage of limit orders is the “name your price” feature which helps ensure that you will only complete your within your stated “limit” range. 

As an example, if you’re using a limit order when buying or selling stocks, it can be a useful technique to limit how much you spend as well as fine-tune how much you earn. Generally speaking, a limit order may be appropriate for any of the following scenarios:

You have a specific target price in mind

The price certainty that limit orders provide make them ideal for both buyers and sellers of securities seeking to achieve specific price points. This can be useful if the margin for profit in your trade might be razor thin.

Pro Tip: Combining tools with analysis
Limit orders used in tandem with sound fundamental and/or technical analyses can be a powerful combination indeed.

You want your target price without actively monitoring the market

Similar to other common order types, you can set limit orders to last a single trading day or keep them outstanding for an extended period of time using a “Good-till-Cancelled” (GTC) order. In most cases, Good-til-Cancelled limit orders will expire after 90 days, but depending on your brokerage firm, can expire within as little as 30 days.

In either case, this negates the need for a trader to continually monitor price levels. At any time a limit order is active, it will automatically trigger if the target limit price is tripped, without the need for the trader to re-enter their order.

You’re trading illiquid securities

It’s a good idea to use limit orders for illiquid securities, like small-cap firms with relatively short track records or investments that don’t actively trade on a major exchange. Due to the limited number of orders that exist at any time for these types of investments, it may be risky to use a market order due to lack of clarity into what your execution price might be.

There’s generally less trade volume available for smaller illiquid investments than larger-cap actively-traded investments. This can lead to a wider spread of the potential prices you might obtain, should you proceed with a standard market order. The limit order caps your risk to wide fluctuations in pricing because it ensures that your trade will only execute if it meets your specified price level or better.

How to Place a Limit Order

You can place a limit order through the standard order placement system of most brokerage accounts. This process is similar regardless of which brokerage firm you have and generally follows the order below:

  1. First, select the transaction type to confirm whether you’re buying a stock, bond, mutual fund, etc, and confirm the security you’re purchasing by entering its ticker symbol. 
  2. Second, select whether your trade action is a buy or sell limit order, contingent on whether you wish to buy or sell a security from your portfolio. 
  3. Third, select “limit” as your order type and enter the quantity of shares you wish to buy/sell.
  4. Finally, select the “time in force,” or period when you’d like the order to be executed. We outline the most common options below:
    • Day – Order outstanding until the close of the trading day
    • Good ‘til Cancelled – Order outstanding until manually canceled by user or mandatory expiration period (typically 30 – 90 days for most brokers)
    • Fill or Kill – Order must be filled immediately in its entirety within the parameters of the target limit price or the entire order is cancelled. No partial execution allowed.
    • Immediate or Cancel – Order must be filled immediately within the parameters of the target limit price or the entire order is cancelled. Unlike a fill or kill order, immediate or cancel orders allow for partial execution.
    • On the Open – Order completes if the market open price fits the parameters of the limit price target. Otherwise the order expires immediately after the market opens.

Limit Orders vs Market Orders

While a limit order helps the trader calibrate their execution price, it does the trader no good if prevailing market prices never reach the target limit price. If the completion of the trade is imperative, a market order may be better suited for the trader’s purpose. 

The key to deciding whether you should proceed with a limit order or a market order depends on your priorities when it comes to order price versus speed and execution certainty. Limit orders take longer to execute on average and also run the risk of remaining unfilled if prices never reach your set target limit. 

By contrast, market orders run the risk of executing at a disadvantageous price when compared to the prices trading on screen, however market orders will almost always execute in a timely manner.

Limit Orders vs Stop Orders

Both limit orders and stop orders are conditional trades that only complete if the price of the security in question hits the target limit or stop price. However, where a limit order is technically a live order and will automatically execute if the prevailing market price reaches target limit price or better, a stop order technically doesn’t exist until the target stop price is reached, at which point, the stop price will automatically convert and execute as a market order.

Stop orders, also known as stop-loss orders are typically used as triggers to limit the downside risk for owners of securities. In another light, they can also be viewed to lock in profits before a security falls beneath a specific trigger level for the security-owner. One of the short-comings of stop orders is due to the underlying market order that executes which can result in volatility for the trader’s final execution price. Stop-limit orders also exist as a separate trade type that can provide more control over execution price.