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What Is a Buy Limit Order?
Is the purpose of “buy limits” to buy stock at a specific price or lower? They are entered below the market. A buy limit order is used when an investor wants to open a long position in a stock at a certain price, while a stop order is used by an investor who wants to lock in profits or limit losses by exiting a position. Imagine Apple’s stock (AAPL) is said to be sold at $118, it must be below. If someone enters a Buy AAPL at $120, what happens? This is our limit order because we have the price and that is what we are willing to pay. Say a person is willing to pay $120, but the stock is being sold for $118, what will happen? It is going to be executed immediately. It is not going to be a conversion to a market order. This is called a marketable limit order. It is not that it is against the rules to place it above, the person is just going to get a pill.
What Are Marketable Limit Orders?
Imagine you go into a car dealer, and the car you want to buy is $20,000. When you walk in, you say, “I will pay $25,000 or less, but no more.” Well, what is the car salesperson going to say? “The car costs 20 grand. You said you won’t pay any more than 25 grand.” What’s about to happen? Yeah. Sold. Done. That’s a marketable limit order.
Now, how does it really work? Well, in the real world, we would say Buy AAPL $110, buy you cannot buy it at $110. So, our order rests, it waits, which is why you place it below. We wait for it to drop. The car is 20k, and you say, “I will pay 15k but no more.” Right? The dealer says, “You know, let’s wait and see if a car becomes available at that price. We cannot sell you that car right now for 15k, but I understand you are willing to pay it, so therefore we will keep your number, if it becomes available at that price, we will give you a call.” That is why it must be entered below. If you put it above, you are just going to get immediate execution. What happens to my buy limit $110 if Apple declares a $1 dividend? The buy limit is now $109, and AAPL is now $117, we adjusted downwards. You can do this same exercise with the sell limit order. It is the same process that you would want to be thinking about.