Buy Limit Order: Definition, Advantages & Disadvantages, and Illustration

A buy limit order is an instruction to acquire an asset at a designated price or lower, offering traders control over their purchasing costs. This type of order guarantees that the investor will pay the specified price or less, but it does not guarantee execution.

The execution of a buy limit order depends on whether the asking price reaches or falls below the specified limit price. If the asset fails to reach the limit price, the order remains unfilled, causing the investor to potentially miss out on the trading opportunity. Essentially, a buy limit order ensures that the investor pays the limit price or better, but it does not guarantee order fulfillment.

Investors who anticipate a decline in the asset's price find buy limit orders beneficial. Conversely, if the investor is comfortable paying the current price or even higher if the asset begins to rise, a market order or buy stop-limit order would be a more suitable choice.

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Key Takeaways

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• A buy limit order enables the purchase of an asset at or below a predetermined maximum price.
• However, a buy limit order may go unfilled if the price fails to reach the limit or moves too quickly.
• Buy limits offer cost control but can lead to missed opportunities in rapidly changing market conditions.
• Each order type has its own advantages and disadvantages.

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Benefits of a Buy Limit Order

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Price Control: A buy limit order ensures that the buyer does not pay a higher price than expected. It allows investors and traders to enter a position precisely. For example, if a stock is trading at $2.45, a buy limit order can be placed at $2.40. If the price drops to $2.40 or below, the order is automatically executed, preventing the investor from paying more than the specified price.

Price Improvement: Buy limit orders can benefit from price gaps that occur between consecutive trading days. If a buy order is not executed during the trading day but remains active, it can take advantage of a gap down. Suppose the stock opens the next day at $2.20. In that case, the trader will purchase the shares at $2.20 since it was the first price available at or below the limit price of $2.40. While the trader pays a lower price than anticipated, it is essential to evaluate why the price experienced a significant drop and reassess the decision to own the shares.

Control Over Purchase Price: Unlike market orders where traders buy at the prevailing offer price, a buy limit order is placed on a broker's order book at a specific price. By indicating their willingness to buy a certain number of shares at the limit price, the trade is executed as the asset's price nears the limit. This approach allows investors to determine the price at which they acquire the shares.

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Special Considerations

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A buy limit order is placed on the order book below the current market price, reflecting the trader's desire to purchase at that price. If the price reaches the buy limit level, and a seller transacts with the order (filling the buy limit order), the investor buys at the bid price, avoiding paying the spread. This can be beneficial for day traders seeking small, quick profits. Institutional investors who hold large positions may use incremental limit orders at different price levels to achieve the best average price for their entire order.

Buy limit orders are also valuable in volatile markets. For example, if a trader wishes to purchase a stock but expects wild price swings, they can set a buy limit at a specific price. If the stock opens higher than the buy limit price the next day, the order will not be filled, protecting the trader from paying more than intended.

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Disadvantages of a Buy Limit Order

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Execution Risk: A buy limit order does not guarantee execution. Even if the asset's price reaches the buy limit order price, there may be a significant number of shares ahead in the queue, making it necessary for the price to surpass the buy limit order level to fill the order. Placing the buy limit order early increases the chances of being filled if the asset trades at the buy limit price.

Missed Opportunities: Buy limit orders can result in missed trading opportunities. While they control costs and the amount paid for an asset, they may prevent investors from taking advantage of a rapidly rising asset. If the price quickly surges without pulling back to the buy limit price, the order may go unfilled, causing the trader to miss out on the upward movement. If the goal is to enter the trade at any cost, a market order can be used. Alternatively, if the investor wants to control the purchase price but is willing to pay a higher amount, a buy stop-limit order is a more suitable option.

Commission Variation: Some brokers may charge higher commissions for buy limit orders compared to market orders. However, this practice is becoming less common as most brokers charge flat fees, fees based on the number of shares traded or the dollar amount, and do not differentiate based on order type.

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Buy Limit Order Example

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Let's consider an example with Apple stock. The bid price is $125.25, and the offer price is $125.26. An investor decides to add Apple to their portfolio and has several order types to choose from. They can use a market order to buy the stock at $125.26, assuming there are enough shares available at that price to fulfill the order. Alternatively, they can opt for a buy limit order with a maximum price of $125.25 or lower.

Suppose the investor expects a slight price decline over the next few weeks and places a buy limit order at $121. If Apple's stock reaches $121 (ideally $120.99 to ensure order fulfillment), the investor will acquire the shares at $121, resulting in significant savings compared to the initial price of $125.25/26.

However, it is also possible that the price does not drop to $121. Instead, it may increase from the bid price of $125.25 to $126, then $127, and eventually to $140 over the following weeks. In this scenario, the investor would have missed the opportunity to participate in the price rise because their buy limit order at $121 was not executed.

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How to Place a Buy Limit Order

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To place a buy limit order, follow these steps:

Determine the limit price: Set the maximum price you are willing to pay for the security.

Choose the order's expiration: Decide whether the order will expire at the end of the trading day if it remains unfilled or if it should be placed as good 'til canceled (GTC). Keep in mind that brokerage firms may impose time limits on GTC orders, usually up to 90 days.

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What Is a Buy Stop-Limit Order?

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A buy stop-limit order combines features of both stop and limit orders. To place a buy stop-limit order, you need to specify two price points. The first is the stop price, which acts as the starting point for the trade's target price. The second is the limit price, representing the upper limit of the desired price target. Additionally, you must set a time frame during which the trade is considered executable.

Once the stop price is reached, the buy stop-limit order converts into a limit order. It will then be executed at the specified price or a better one. The primary advantage of a buy stop-limit order is that it allows traders to exercise better control over the price at which they purchase a security.

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What Happens If a Buy Limit Order Is Not Executed?

If a buy limit order is not executed, it will expire without being filled. The order can either expire at the end of the trading day or, in the case of a good 'til canceled (GTC) order, it will remain active until the trader cancels it. One of the advantages of a buy limit order is that it guarantees the investor will pay the specified price or less for the security. However, the downside is that there is no assurance that the order will be executed.

Traders should be aware of the risks involved in placing buy limit orders. The market conditions, liquidity, and trading volume can all affect the likelihood of order execution. If the price does not reach the specified limit or quickly moves beyond it, the buy limit order may go unfilled, resulting in missed trading opportunities.

In summary, buy limit orders offer price control and the potential for price improvement, allowing investors to define their purchase price and potentially benefit from price gaps. However, there is no guarantee of execution, and traders should carefully consider market conditions and their trading objectives before utilizing buy limit orders.

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