If completing a trade is essential, then a market order is the ideal one. But if buying a share at a specific price is a deciding factor, then a limit order is the perfect one.
Limit orders are a type of order for buying shares in the stock market. Under this order, the investor indicates or keys in his preferred price limit beyond which he will not buy or sell. This stipulation allows investors to monitor the rates. Let us discuss in detail the mechanics of limit order and how investors can benefit from the same.
Mechanics behind limit order
A limit order is the usage of a predetermined price to buy or sell a share. Unless both price and quantity conditions set by the investor are met, the order cannot be executed. For instance, if ABC share is currently trading at Rs 200 but you are only willing to pay Rs 192 you can enter a limit order at Rs 192. Your order will be executed only if the price falls to Rs 192 or below.
As the order cannot be executed immediately, it remains in the order book and valid till the end of the trading session, if not executed. Many broking houses allow limit orders to be placed even on holidays and during non-market hours also.
When to place limit order?
A limit order should be placed by the investor when the market is volatile and the investor expects the price to come down from the day’s high. Often, one can place the order at a level perceived to be good from a fundamental and technical point of view. Further, a limit order may be useful if an investor does not watch a stock on a continuous basis and has arrived at a certain price at which he will be glad to buy or sell.
Shortcomings of limit order
It is important to note that while placing a limit order it is possible to gain control on the price of a share and investors can capitalise on short-term market fluctuations in their favour. But there is no assurance that investors are able to attain the quantity of stock which they desire. In other words, if the desired price does not reach until the end of the trading session, then the order is not executed and the investor might lose an investment opportunity.
Market order vs limit order
Market orders are transactions that are intended to be executed at the current and ongoing market price at the earliest possible. The price of the share is secondary but the speed at which the trade to be executed is primary. So, a market order deals with executing the order. But, a limit order sets the price at which one is willing to buy or sell. Limit orders deal primarily with the price and if the price ranges outside the parameters set in the limit order, then the trade will not take place. The major risk of using a market order over the limit order is that investors have no control over the price. During a volatile market, if a share’s price suddenly moves just before you place a market order then you end up paying more or receiving much less than you expected.
To conclude, if completing a trade and getting the shares credited into your demat account is important for you, then a market order is the ideal one. But if buying a share at a specific price is a deciding factor, then a limit order is the perfect one.
The writer is a professor of finance & accounting, IIM Tiruchirappalli