A limit order is a financial tool that allows you to control the amount of money spent on a stock transaction.
The two common types of limit orders are a buy limit order and a sell limit order. When executing a buy limit order, a maximum price is selected. This is the highest price per share that you are willing to pay for a specific stock. For example, you want to buy 100 shares of stock A that is currently selling at $12 per share. You have done your financial analysis and create a limit order setting the maximum price at $10 per share. The most you will pay when the trade executes is $1000 (100 shares times $10). The trade can be completed when the price per share hits or falls below your $10 limit.
A sell limit order is the reverse of a buy order. You set the minimum amount per share that you want to sell your stock. Let’s say you own 200 shares of Stock B that you originally purchased for $10 a share. The stock has done well and is now trading at $12 a share. You think the stock still has more growth potential and you do not want to be too greedy, so you decide to create a sell limit order for your 200 shares at $13 a share. Your shares will not be sold until the price reaches at least $13.
A time limit for a limit order to remain in effect can be set when the order is created. These options include Good til Filled (GTC), Fill or Kill, and Immediate or Cancel. Good til filled means that the order will remain open until filled, canceled by you, or a designated number of days have passed since the order was created. The number of days that a limit order remains in effect without being canceled varies with each brokerage house, so be sure to check the rules for your specific broker. Fill or Kill means the order must be filled completely, all requested shares bought or sold. No partial trades are allowed. The Immediate or Cancel orders can be partially filled. Be aware that some brokerage houses may charge multiple commissions on orders that are filled over several days.
The main disadvantage of limit orders is that these trades may never be executed if the limit prices are not reached. In the buy example above, if the price fails to drop to $10 a share or below, no purchase will be made. The same is true for the sell order. If the sell price of $13 dollars is never reached, your shares will not be sold. In some cases, even if the stock price reaches your purchase limit, execution of the trade may not take place if there are not enough shares available to meet the demand for the stock. Multiple limit orders for a stock are filled on a first-in-first-out basis.