The stock market operates as a double auction market. The buyer offers to purchase a specific number of shares of stock while the seller offers to sell a specific number of shares of stock. A stock trade is made when the two parties agree on a price. There are a number of different types of orders, including limit orders, that designate the price at which a buyer or seller is willing to make the trade.
One of the most common types of stock trade orders is the order to trade at the market. Market orders will execute at whatever price the market dictates. The problem with a market order is that the last trade is not necessarily indicative of the price of the next trade. You may end up buying or selling your stock for a much higher or lower price than you anticipated. You can reduce your risk of an unexpected difference in the price of your stock transaction by entering a limit order instead of a market order.
You can designate the highest price you are willing to pay for your stock transaction by entering a buy limit order. The order will only execute if a seller is willing to sell his stock at or below the limit price of your order. You can also use limit orders when you sell your stock by issuing a sell limit order. This order will only execute if a buyer is willing to pay at least the amount of your limit price.
Benefits and Limitations
A buy limit order protects you against an unexpected spike in the stock price while a sell limit order prevents a stock trade from occurring at a price that is below the amount you are willing to take. You may receive stock trades at different price points until the entire order is filled. While a market order will be filled at what ever price the market will bear, there is no guarantee that your limit order will be filled.
You can combine a limit order with other types of stock trade orders, such as a stop-limit order. The stop order becomes a market order once the stop price is reached. The market order will remain in force until limit price is reached, at which time the order ceases to be in effect. This type of combination order allows you to control the trading range of your stock.
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