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Importance of Limit Orders


“The volatile markets today can be unpredictable at times. Even if the quoted price is $25.50 and you place a market order, this does not guarantee that you will purchase it at $25.50”

By Alex Vo, Contributing Blogger
From Vo Industries
Content Partner

From www.financialimbalance.com

Introduction

Assuming you have already opened an account, you will need to place your first trade. Depending on your trading platform, you will see different order types such as Market (current market price), GTC (good until cancelled) and GTEM (good until extended market, i.e.: after hours trading). There are also advanced ones such as FOK (fill or kill) or IOC (immediate or cancel). You may not have the option to use those if you are using a basic platform to trade with.

This post will not talk about order types, however. There are three issues that I want to cover in this blog post. The first two are how to place a buy and sell order using limits and the benefits of not using the market price. I will also explain what the bid/ask spread is and how to ensure there are no surprises on the purchase/sold price after your trade has been executed.

Purchasing Shares

First of all, when purchasing a stock, you should always use a limit order. A limit order is a price you set that you would like to purchase a stock at. Say the market price of a stock is $25.50. If you place a limit order at $25.40, the trade will execute when you reach that price. What if you are happy with paying $25.50? Place a limit order at $25.50! There are countless times when I first started trading/investing where after placing a market order, I would end up purchasing a share at a price higher than what was quoted when I clicked the trade button. The volatile markets today can be unpredictable at times. Even if the quoted price is $25.50 and you place a market order, this does not guarantee that you will purchase it at $25.50.


Bid/Ask Spread

This is very important if you are trading options, as those generally have higher spreads (difference between the bid and ask price). The bid price is the price that a buyer is willing to buy a security for and the ask price is the price that a seller is willing to sell a security for. The less liquid a security is, the larger the spread is generally. It is important that you make trades that have a very small spread. To explain, if there is a $1 spread on a security, this means that purchasing it will cause you to lose $1 already. For example, if the ask price is $51 and the bid price is $50, this means that a purchase can be made for $51 but can only be sold for $50. To help reduce the spread, a limit order can be placed in between the bid and ask prices. This large amount allies to options more than shares of a company.

Selling Shares

A limit order works the same way when selling shares. If the market price is $40 but would like to sell once it hits $40.50, you can place a limit order at that price and the trade will execute once there is a buyer for $40.50. Similarly, selling your stock at market price does not ensure you get the price that you see quoted when you click the button.

This is a short post but covers very important information that future investors should know. As usual, please feel free to ask any questions in the comment box below. There is no need to register for an account to do so and the information required to write a comment does not get verified. This means you can put fake information down and ask your questions anonymously. Please make use of this!


By Alex Vo, Contributing Blogger
From Vo Industries
Content Partner

In association with:

The ARB Team
Arbitrage Magazine
Business News with BITE

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