Last Updated on September 27, 2023 by BFSLTeam BFSLTeam
When you place a market transaction on the stock exchange via your brokerage account, the trade occurs at the current market rate — assuming sufficient buyers or sellers are present. However, during turbulent market conditions, there might be some price discrepancies. This implies your transaction might not finalise at the anticipated rate. Based on the extent of this discrepancy, your gains could diminish, or you might even face negative returns on the transaction.
For example, say you purchased 1,000 shares of a company at Rs. 50 each, and you want to sell them now because the company’s share price is Rs. 65. You expect a profit of Rs. 15,000. So, you place a market order where the shares will be sold at the current market price. But by the time your order is executed, the company’s share price dips to Rs. 60 per share, giving you a profit of only Rs. 10,000.
To avoid this issue, you can place a limit order instead. Not sure what a limit order in the share market is and how it works? In this article, we’ll take a closer look at this type of stock market order, so you can use it to your advantage.
Table of Content
What is a Limit Order?
A limit order is a directive given through your brokerage account, indicating a specific quantity of stocks or securities to be bought or sold at a set (or more favourable) price. This kind of transaction gives you greater control over the prices at which you buy or sell shares and securities in the market. With a limit order, the rate is pre-established, but the completion of the trade depends on market fluctuations and the bid-ask spread.
Let’s take a closer look at the prices at which a limit order is typically executed.
- A buy order with a limit is executed at the specified price or a lower price.
- A sell order with a limit is executed at the specified price or a higher price.
This is because purchases are more profitable when you make them at lower prices, while sales are more profitable when they are made at higher prices.
How Does a Limit Order Work?
Let’s discuss an example to better understand how limit orders work. Say you want to buy 500 shares of a company at Rs. 50 per share. However, the current market price of the company’s shares is Rs. 58.
You expect the price to drop to Rs. 50 or lower by the end of the trading session, so you place a limit order in the share market to buy 500 shares of the company at Rs. 50. If the company’s share price drops to this level during the trading session and if there are adequate shares available for sale at this price, your limit order will be executed.
However, let’s say the market is extremely volatile, and the share price drops from Rs. 58 to Rs. 54 and then straight to Rs. 48. In that case, your limit order will be executed at Rs. 48, which is a better price than what you specified.
Things to Know Before Placing a Limit Order
Here are some important things you need to keep in mind before you place a limit order in the share market.
- Limit Orders Need to be Used Under the Right Conditions
A limit order is better suited for certain conditions. If the market is extremely volatile, using market orders will result in a great deal of slippage. You can avoid this by using limit orders instead. A limit order may also be suitable if you are not in a hurry, or if you do not have the time to monitor the market round the clock.
- It is Important to Set Realistic Limits
The limits you set for your orders need to be realistic. If you place a sell order with an unrealistically high price limit or a buy order with an unrealistically low price limit, that price may never be attained during a given trading session. This means your order may lapse (unless it is a ‘Good Till Trigger’ or GTT order). Even then, it may take several days for the price to reach your desired limits.
- Limit Orders Do Not Guarantee Execution
Even if the price of the share attains the level you’ve set via a limit order, your buy or sell transaction will only be executed if there is enough liquidity in the market. If there are not enough buyers for the shares you are selling (or sellers for the shares you want to buy), your order may be partially executed or not executed at all.
Conclusion
This sums up what a limit order in the share market is and how it works. You can use this kind of order to your advantage if you want to ensure that you do not miss out on a lucrative trading opportunity. To get started with stock market trading and use limit orders to make custom trades, open a demat and trading account with Bajaj Financial Securities Limited today via a simple 3-step process, and experience the advantage offered by BFSL.
