Buyers must set limits because sellers rarely do…
Our next article focuses on an aspect of stock market trading that is rarely discussed but is as important as taking the time to make stocks a part of your life. It is called limits, or limit trading. But before we get to limits, let’s briefly talk about market orders.
What is a market order?
Wiki defines it as “a buy or sell order to be executed immediately at current market prices.” As long as there are willing sellers and buyers, market orders are filled. Market orders are therefore used when certainty of execution is a priority over price of execution. A market order is the simplest of the order types.
So let’s translate this quickly. A market order is a request to buy or sell a stock at its earliest availability, regardless of price. Look at the last 5 words of that sentence: “Earliest availability regardless of price.”
When have you ever purchased a car and used those words? Hopefully never.
Let’s look at an example of a market order in its true potential ugliness:
Mike is looking to buy a share of the hot IPO Snap Inc (SNAP). John is looking to sell a share of the hot IPO SNAP. The current price for SNAP is $27 a share. John sets a sell order with a limit price of $35. Mike places a market order (see definition above). Mike has just bought John’s share for $35. Right afterwards the next trade of SNAP sells for $27. Congratulations Mike, your market order has just secured you an $8 loss in less than a second.
What is a limit order?
Wiki defines it as “a direction given to a broker to buy or sell a security (stock) or commodity at a specified price or better.” What this means is instead of Mike buying a share at any price (market order), Mike places a limit order. In this limit order Mike specifies he is willing to pay no more than $27 for a share. This limit prevents John from selling his share to Mike for $35. Mike determines the maximum he’s willing to spend on a share and a deal isn’t done unless Mike gets his price.
How do I set a limit order?
Different sites have different ways of doing this, but since we always recommend using Robinhood, let’s do so as our example.
1. Login to your Robinhood account. Select the stock you want to buy. Press the “Buy” button.
2. At the top right corner in green is a tab named “Order Types.” Select it.
3. Select the “Limit” field. Using the current price as a guide, enter the price you are willing to pay and press “Continue.” Keep in mind your limit should be within reason or the trade will not occur.
4. Set the length of time you want to keep this limit open for. We suggest no longer than “Good for Day.”
5. Enter your number of shares and hit “Review.”
6. Swipe to confirm and you are all done!
Setting limits protects the investor from buying or selling shares at any price. Now that you’ve been investing for a while, it’s a great idea to employ limits. It’ll save you in the long run.