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What is a Limit order?

What is a Limit order?
Asked by
Curtis Davis categorie-icon time-icon5 months ago

Sheila Olson
Answered time-icon5 months ago

A Limit order is an automated instruction to enter into a trade at a pre-determined price. Limit Orders are placed in advance of a price getting to that particular level with the intention of executing at a level that best fits a particular trading strategy.

Limit orders are determined by individual traders who then input that information into the Broker Platform they are using. There is then a period of waiting to see if the Limit Order is activated, or not. If a price does not reach the pre-determined level the trade is not executed.

The below example demonstrates a Limit Order being set to enter into a Momentum trade using a 1hr time frame.

Current Price is 7055
Limit Order Instruction: SELL
Limit Order Price: 7069
drop

Source: IG Index 20181114

With indicators advising momentum is to the downside the trader is looking to enter into a Short position, but the question is where? They enter a Sell Limit Order with a price of 7069 which is in line with the upcoming Resistance level, the Weighted Moving Average (100). Two of the last three candles have been very bullish which increases the risk that a trend reversal is about to happen, which would mean momentum switching from bearish to bullish, or at least to sideways. However, the trading volumes chart at the bottom of the illustration does not show significant upticks in volume suggesting the very recent price action to the upside might not be widely supported.

Entering into the trade at the higher price of 7069 would not only maximize returns should the momentum continue to the downside but would also minimize losses if the market momentum has indeed actually turned and goes on to hit the Stop Loss order.

Source: IG Index 20181114

One hour later we can see the Limit Order price of 7069 was just touched (upper shadow of red candle, above) and the Short position taken. Price is currently 7059.3 representing an unrealized profit.

Pros

  • The automated nature is a big advantage, especially if you want to trade when you are without direct access to the markets.
  • Limit orders also free up your time as you are not concentrating on trade execution.
  • A disciplined approach to applying trading strategies is always a good thing. Limit orders help you build a trading environment that is based on analytics rather than emotions.

 

Cons

  • Using Limit Orders can obviously mean you might not enter into a trade. That can be frustrating if post-trade analysis shows that the trade would have been profitable if you had just got into it at less optimal levels. It would be prudent, however, to devote time to re-evaluating your trading strategy (specifically trade entry points) rather than your trade execution policy.
  • As with Stop Losses news events such as the release of economic data, although running to fixed schedules, can still create momentary periods of abnormally high price volatility and a whip-sawing price action. Until the market digests the news spikes in prices can hit Limit Order and it would be important to consider if you find the chance of getting into a trade to be of benefit

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