Limit and Stop Orders

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What is meant by a limit order?

When an order is placed for the sake of purchasing stock at a particular desired price, it is referred to as a limit order. Hence, this implies that either a lower or the set limit price is the only price level used when executing a buy-order limit.

On the other hand, a higher price or the sell limit order price is the only one applicable when implementing a sell limit order (Hirt & Block, 2012). On the same note, there is no guarantee to execute any form of a limit order. Hence, unless a limit price is attained by the stock market, it may not be possible to fill a limit order.

One of the outstanding merits of a limit order is that it protects investors from exploitation especially when buying and selling stocks from unscrupulous traders. In fact, the pre-determined price is adhered to even if execution is not guaranteed by a limit order (O’Neill, 2012).

Similarities and differences between a limit order and a stop order

In order to limit possible losses that may be incurred in course of trading stocks, a stop-loss order or simply a stop order is applied. As already hinted out, this type of order offers specific trading instructions to a stockbroker in order to understand when to implement certain transactions since a particular market price should be reached.

Nonetheless, both the limit and sell orders have distinct similarities and differences when used in a stock market scenario. It is vital to note that all types of securities may benefit from the principles of stop and limit orders.

To begin with, a limit order is implemented based on the set or predetermined price. Nevertheless, a better price than the set price can still be used to execute a transaction. Limit orders typically seek to buy at the most minimum market price or the set target price of a stock (Linnainmaa, 2010).

On the same note, sales are made at a given fixed price or at a higher value. However, a stop order works quite differently. A broker is usually given an instruction to execute the transaction if the market price for a stock traverses above the desired target.

In the case of sell orders, brokers are only supposed to execute the transactions if prices go below a given value. In regards to buy orders, brokers ca only purchase if price jumps above a given dollar amount.

Second, execution of limit orders is usually guaranteed. As a result, desired prices are locked by investors. Once the required prices have been fixed, it is possible for investors to reap the desired profit margins. Nevertheless, the intent is different when it comes to stop orders (Ya-Hui & Chien-Chih, 2015).

The main purpose of a stop order is to evade losses that may be incurred in course of trading. Potential losses may be avoided by an investor through a stop order. For instance, buying and selling of securities may be halted for a while if stock price movements are not favorable.

In other words, a ceiling is placed by a stop order each time there is a likelihood of a loss. Needless to say, both a limit and stop order are similar because they serve specific intentions and are meant to improve the profit margin for investors in the stock market. In addition, each order requires an instruction before the process of execution.

Describe circumstances (with examples) under which the use of these orders would be appropriate

Both buy and sell limit orders are beneficial to investors in the stock market. For example, if an investor wishes to purchase a security for $20 or less, a buy limit order can be appropriately applied. In this case, a limit price of $20 or less can be entered by the buyer.

Thereafter, the security can be purchased only if trades at the rate of $20 or lower than $20. In the event that the security exceeds the set limit price, the transaction will not be executed at all.

In addition, it is crucial to mention that the present Ask price is often equal or less than the limit price (for a buy order) in order to facilitate the buying process (Linnainmaa, 2010).

In regards to a sell Limit Order, investors are also protected by a similar principle. For example, if an investor desires to sell a security worth $30 or even more, it is acceptable to set $30 as the limit price.

After this initial process, the security can only be sold at the set price or more so that the owner of the securities can reach the projected profitability goals. This implies that there will be no execution if the security trades below the predetermined $30.

It is a common practice to use the higher level of the current Bid price when setting the limit price. In other words, the latter price is set at the prevailing Bid price or at a higher possible value.

In some instances, a single day might not be enough to fill a limit order (Hirt & Block, 2012). Hence, there are some cases when several days might be required to fill a limit order. Every day that a fill takes place; transaction costs should be equally reflected.

References

Hirt,G. & Block, S. (2012). Fundamentals of investment management. (10th ed.). New York, NY: McGraw-Hill Irwin.

Linnainmaa, J. T. (2010). Do Limit Orders Alter Inferences about Investor Performance and Behavior? Journal of Finance, 65(4), 1473-1506.

O’Neill, K. M. (2012). Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change Relating to the Handling of Stop and Stop Limit Orders. Federal Register, 77(175), 55517-55519.

Ya-Hui, W., & Chien-Chih, L. (2015). The Effect of Limit Order Book Information on Investors with Different Risk Attitudes. International Journal Of Business & Finance Research (IJBFR), 9(1), 113-120.

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Limit and Stop Orders

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