LIMIT ORDER

A limit order is a type of contingent order because the order does not get executed unless the market price first reaches a certain point, in this case, the limit price. You will use a limit order to instruct your broker to sell if prices rally to a certain point (the limit price), or to buy if prices fall to a certain point (the limit price). Consequently, a limit order to sell has a price that is above the market price while a limit order to buy has a price that is below the market price.

A limit order can be used to establish a new position or to close an existing or open position and there is usually no distinction made between the two among brokers or on most trading platforms.

Establishing a New Position

A limit order can be used to establish a new position and it is typically used in this manner when the trader wishes to buy on a dip in price or sell on a rally in price. In other words, the trader is hoping to buy at a price that is cheaper than the market price or to sell at a price that is more expensive than the market price. For example, let's say that the market price is currently at 80. A trader who wishes to buy should the price drop to say, 75, will enter a limit buy order at 75. A trader who wishes to sell should the price rally to say, 85, will enter a limit sell order at 85. At what price below or above the market price should the limit order be set will depend upon the rules of your trading system.

Closing an Open Position

A limit order can also be used to automatically close an open position should the market move favorably. A long position will be accompanied by a limit sell order set above the market price. Should prices rally to the limit price, the sell order will be executed thereby closing the open long position (assuming that there are no other positions open in that particular contract market). Conversely, a short position will be accompanied by a limit buy order set below the market price. Should prices fall to the limit price, the buy order will be executed thereby closing the open short position (again, assuming that there are no other positions open in that particular contract market).

Operational Details

Limit orders are usually filled at the limit price and cannot be filled worse than the limit price. If a market is very volatile and moves suddenly, or if the market opens at a price significantly different from the prior day's closing price, in other words, the market price "gaps" on the open, then a limit order can return a fill at a price that is better than the fill price. A limit order remains on the book until the order is either executed, canceled or expires. Any portion of the order that can be matched is immediately executed with the balance remaining to be filled unless the customer qualifies the order as fill-or-kill in which case the entire order is filled or not at all.