Limit orders provide traders with the ability to specify a desired price level for entering or exiting a position.
This type of order offers greater control over the execution price, allowing traders to minimize slippage and maximize potential profits.
What is a Limit Order?
A limit order is an order placed to either buy below the market or sell above the market at a certain price.
It is an instruction to your broker to execute a trade at a particular level that is more favorable than the current market price.
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The blue dot is the current price.
Notice how the green line is below the current price. If you place a BUY limit order here, in order for it to be triggered, the price would have to fall down here first.
Notice how the red line is above the current price. If you place a SELL limit order here, in order for it to be triggered, the price would have to rise up here first.
Limit orders differ from market orders, which instruct your broker to execute a trade at the best current available price.
Limit orders allow you to specify the minimum price at which you will sell or the maximum at which you will buy.
If you want to open an order to buy or sell an asset at a price that is less favorable than the current market price, you use a stop order.
There are two varieties of limit orders
- Entry orders (that open a new position)
- Closing orders (that terminate an open position)
By using both, traders are able to execute a trade automatically at a certain level instead of constantly tracking the price of an underlying asset.
Entry Limit Order Example
For example, EUR/USD is currently trading at 1.1050. You want to go short if the price reaches 1.2070.
You can either sit in front of your monitor and wait for it to hit 1.1070 (at which point you would click a sell market order).
Or you can set a sell limit order at 1.1070 (then you could walk away from your computer to attend your ballroom dancing class).
If the price goes up to 1.1070, your forex trading platform will automatically execute a sell order at the best available price.
You use this type of entry order when you believe the price will reverse upon hitting the price you specified!
A limit order to BUY at a price below the current market price will be executed at a price equal to or less than the specified price.
A limit order to SELL at a price above the current market price will be executed at a price equal to or more than the specific price.
When should you use a limit order?
You should use limit orders when you are not in a rush to buy or sell.
Unlike market orders, the limit orders are not executed instantly, so you need to wait until your ask/bid price is reached.
Limit orders allow you to get better selling and buying prices and they are usually placed on major support and resistance levels.
Benefits of Limit Orders
- Price Control: Limit orders allow traders to specify the exact price at which they want to enter or exit a position, providing greater control over the execution price and potential profits.
- Reduced Slippage: By specifying a precise price level, traders can minimize the risk of slippage, which occurs when an order is executed at a worse price than the intended price.
- Risk Management: Limit orders can be used as part of a risk management strategy to set predefined entry and exit points, helping traders to protect their investments and lock in profits.
Drawbacks of Limit Orders
- Execution Uncertainty: Since Limit orders are only executed when the market price reaches the specified limit, there is no guarantee that the order will be filled. This can result in missed trading opportunities if the market moves quickly and does not reach the desired price level.
- Slower Execution: Limit orders may take longer to be executed compared to market orders, as they depend on market conditions and the availability of buyers or sellers at the specified price.
- Partial Fills: In some cases, a Limit order may be partially filled if there is not enough liquidity at the desired price level. This can result in the trader holding a smaller position than initially intended.
Summary
In summary, limit orders offer traders more control over their execution price, allowing them to minimize slippage and maximize potential profits.
A limit order is a type of trading order that instructs a broker to buy or sell a financial instrument at a specific price or better.
These orders allow traders to set a maximum price for buy orders or a minimum price for sell orders, giving them more control over the execution price.
They can also be an effective risk management tool, helping traders set predefined entry and exit points.
However, limit orders come with some potential drawbacks, such as execution uncertainty, slower execution, and the possibility of partial fills.
To mitigate these risks, you should carefully monitor market conditions, consider using other order types when appropriate, and continually refine your strategies based on experience and market analysis.