What is a ‘Buy Limit Order’
A buy limit order is an order to purchase a security at or below a specified price, allowing traders and investors to specify the price they are willing to pay for a security, such as a stock. By using a buy limit order, the investor is guaranteed to pay that price or better, meaning he pays the specified price or less for the purchase of the security. While the price is guaranteed, the filling of the order is not; if the specified price is never met, the order is not filled and the investor may miss out on the trading opportunity.
BREAKING DOWN ‘Buy Limit Order’
A buy limit order ensures that negative slippage does not occur. The buyer does not get a worse price than he expects. Buy limit orders provide investors and traders with a means of precisely entering a position. For example, a buy limit order can be put in for $2.40 when a stock is trading at $2.45. If the price dips to $2.40, the order is automatically executed.
Advantages of Buy Limit Orders
Unlike a market order in which the trader buys at the offer price, a limit order is placed on a broker/dealer’s order book at the specified price. This has the same effect as having an order placed at the bid, signifying that the trader is willing to buy a specific number of shares of the stock at the specified limit price. As the market trades downward toward the limit price, the trade is executed when the limit price becomes the inside bid, thus the trader buys the stock at the lower bid price and avoids the spread. This is very helpful for short-term intraday traders who seek to capture small, quick profits on momentum and swing trade. For large institutional investors who take very large long positions in a stock, incremental limit orders at various price levels are used in an attempt to achieve the best possible average price for the order as a whole.
Disadvantages of Buy Limit Orders
As mentioned earlier, a limit order does not guarantee execution. This happens when the market price trades down to the limit price, be it buy or sell, and immediately turns around and trades right back up. When this happens, the limit order is triggered but not executed, because every trade thereafter is above the limit price at the bid. This phenomenon happens more often on securities that have wider spreads. Market orders to buy a security are executed at the offer price, the higher of bid/offer quotes. Consequently, the market has to trade downward across the spread to the lower bid price so that limit orders can be executed. When the spread is wide, the market may turn back up within the spread, thus missing the trade. Another disadvantage of buy limit orders is the higher commissions that brokers typically charge for them.