What is a buy limit order?
A buy limit order ensures that a trader buys an asset at a specific price or maybe even lower. However, this order cannot assure the trader that the order will be filled. In limit orders, we call the specific price or asking price the “limit price.” The order will proceed to execution if the limit price is hit. However, if not, then the order will not be filled and executed.
In some cases, traders may miss out on an excellent trading opportunity because of this. This order is a wise strategy to use if a trader anticipates a price decline. If the trader expects the opposite, it might be better to consider a buy stop limit order.
A sample scenario with buy limit orders
Paulo is a trader who wants to buy stocks from H Company. However, H Company’s moves up and down every day. The market is volatile. A stock from H Company sells at $50, and Paulo places a buy limit order at $48. The only time that Paulo’s order will proceed to execution is when the limit price hits $48 or lower, nothing more.
Let us say that Paulo’s order did not get filled and executed because the market price stayed at $50. The next day, the stock’s market price declined to $46, lower than Paulo’s placed limit price. As a result, the order gets filled and executed because the buy limit order is still active and not canceled.
Furthermore, let’s say that the stock’s market price was $50 in the closing yesterday. Since Paulo placed a buy limit order at $48 and the stock is at $51 on the opening auction of the next trading day, there will be no fill or execution. This strategy limits what a trader buys; hence its name buy limit order.
The challenges in using a buy limit order
A buy limit only guarantees the price and not the execution since the order only proceeds after hitting the limit price. Besides that, we can say that another challenge is that the order needs to line up in a queue.
Let’s take Paulo’s and H Company’s case again to elaborate. Say Paulo wants to buy 500 shares at $48. Even though the seller is willing to sell at the price that Paulo wants, there may also be hundreds or even thousands of shares still waiting queue to buy H Company’s shares at $48. In this situation, the earlier orders will still need to clear up first before the seller gets to Paulo. We can say that in placing buy limit orders, punctuality is a must.
In another scenario
H Company’s stock is constantly rising. The stock closed yesterday at $50, today it closed at $53, and the next day, it opened at $55. We can conclude that the stock is skyrocketing and not likely to decline anytime soon. However, since Paulo placed a buy limit order at $48 and did not cancel it since he does not want to buy any more than that price, he will not likely proceed to an order fill. We can say that Paulo missed an excellent trading opportunity. He can solve this dilemma by using a market order and buying the stock upfront at its current market price. He can also place a buy-stop order where he might pay a little bit higher but still control the maximum amount that he will pay.