A limit order is a simple instruction to your broker, online or otherwise, that you want to buy or sell a stock at a particular price. Without a limit order, you simply buy and sell at whatever the current market price may be. The advantage of a market order is that your buy or sell will go through right away. The disadvantage of a market order is that you may not get the price you want.
A limit order says, “I will buy this stock at this price or lower.” Or, “I will sell this stock at this price or higher.” That way you determine the price for selling or buying a stock. The downside is that you may never get your price. If you are trying to buy a stock at a certain price, the stock may never go down to your price and your sale won’t go through. The same is true of selling. If the stock never reaches your sell limit, the stock doesn’t get sold.
This is where knowledge about the company is important, as well as a good bit of luck. You always want to buy a stock at a low price. There are a number of frustrations that can occur in this process. You may successfully purchase your stock at a low price with your limit bid. But the stock may continue to go down and you will realize that you could have gotten it cheaper. Or worse, it continues to go down and never comes back up.
The other danger in buying a stock with a limit is that the stock doesn’t drop down to your limit but continues up. This is a real danger because you may end up “chasing the stock.” You chase a stock by raising your limit bid higher as the stock goes up. When you do this, you can end up paying much more than you intended. It is much better to let a stock go when this happens rather than end up paying a high price for a stock that may be near its top.
This often happens when some well-known financial commentator recommends a stock. If a lot of people buy the stock on that recommendation, the stock will go up. If you don’t get in right away, the price can get away from you. Furthermore, the stock may not really be a bargain and it is only going up because of the commentator’s recommendation. These guys are sometimes wrong and you can be left holding the bag as the stock goes down after the initial enthusiasm.
Your limit order may be good for 30 days or more, depending on your brokerage. Sometimes patience is rewarded by leaving your buy or sell open long enough. As I said, there’s a lot of luck involved here.
If you’re going to be successful at using limit orders, you are going to have to leave your emotions out of it. If you fail to buy a stock at its low, let it go. There will be another opportunity. If you fail to sell a stock at its high, don’t cry about it. I have made good profits on a stock and then felt badly because it continued to go up. That’s silly. I still made my profit.
On a final note, limit and stop orders need to be taken into account when you choose a broker. With any online broker, you need to know the total cost of doing business. Some brokers charge extra for limit or stop orders. You need to know this when you decide on a broker. It can make a big difference in your profit and loss columns.