A stock brokerage account gives you more ways to trade stocks in addition to either buying or selling at the current market price. Alternate types of stock market orders -- such as limit orders -- give you more control over the prices at which you buy and sell stock shares. Limit orders are a tool that could improve the profitability of your stock trading.
The regular or standard type of stock market order is called a market order. When you place a market order, you do not know at what price the order will be filled. You see the current stock price on your order screen, but the order will be filled at the current price when it's submitted to the stock trading system. In a fast-moving market, your order fill price may be different from what you expected and impact your trading strategy.
Limit Order Function
A limit order lets you set the price at which you will buy or sell stock. A buy limit order is entered with a price below the current ask price of the stock and would be filled if the stock drops to the limit price or lower. A sell limit order is set above the current bid price of the stock. Limit orders can be filled at the limit price or better. On a sell limit order, you may sell the stock at the limit price or a higher price if the stock moves up between the time the limit order is triggered and when it is filled.
Using Limit Orders
Limit orders can be used to open a stock trade at a price that's better than the current market price or to lock in a profit if a stock you own reaches the limit price. As an example, a stock is trading at $40. You think the stock is going to decline and then rise. You enter a buy limit order at $38 and a sell limit order at $42. If the stock drops to $38 you will buy the shares and your profit will be locked in if the stock rises to $42. In a margin account, if the stock rose to $42 first, you would sell the stock short at the $42 limit price. As the example shows, limit orders can also be used to get in and out of trades to sell stock short.
Limit Order Time Frames
When you place a limit order, the broker will require a time frame on the order. The default time frame is a day order. If this order is not filled by the time the stock market closes for the day, it will be canceled. The other time frame option is called good till cancelled, or GTC. A GTC order remains in effect until it is either filled or you manually cancel the order. If you are using a limit order to close a trade at a profit, you probably want to use the GTC time frame for the order.
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