Stocks are a matter of pure chance in most cases. Unforeseen events such as weather or wars can wreak havoc on share prices of stocks. It’s a good idea to set limits on your activity, so you don’t get burned.
Even if you buy and sell your own stocks, you must depend on at least one other person or entity to ultimately carry out the transaction. It is to this person or entity that you will report your desire to buy or sell at a certain price. You will decide on whatever price you are willing to settle for or achieve, and then tell the transaction agent what that price is. This is called a limit order.
The main advantage of a limit order is that you as the investor can control the maximum or minimum price at which your money is spent or earned. If you specify in your limit order that your limit price is $100 a share, then you will know the limit of the transaction. You will usually specify how many shares you wish to buy or sell as well. Using the same example, if you set a limit price of $100 a share and a share limit of 100 shares, then the most you will spend or gain is $10,000.
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Your limit order is a safeguard against significant loss of money. It is not guaranteed to take effect, however. The share price might never reach your limit order level; if that is the case, then the limit order has not been filled and it either remains in effect or is canceled after a certain amount of time.
By and large, a limit order is found in use more often on a stock exchange than in over-the-counter markets. The main reason for this is the faster rate of fluctuation and overall speed at which prices rise or fall on exchanges. Ironically, because of the intense nature of the up or down swings in price on exchanges, however, a limit order might not be reached unless someone is not paying attention. If you set your limit order price to be so low that only bargain-hunters will be around to buy at that level, then only the bargain-hunter who isn’t paying attention won’t dive in after your stock once it bottoms out.
One drawback of a limit order is that it locks you in to a certain price. You might want to get rid of a stock and set a limit order price that you think is certain to unload all of your shares. If the price never reaches your limit order level, though, you’re stuck with your stock until you can get that limit order lifted. Especially in the case of a stock that you really want to get rid of, setting a limit order might not be the best idea.