What is a Buy Limit Order?
A buy limit order is an order to purchase an asset at or below a specified price, allowing traders to control how much they pay. By using a buy limit order, the investor is guaranteed to pay that price or less. While the price is guaranteed, the filling of the order is not. If the asset does not reach the specified price, the order is not filled and the investor may miss out on the trading opportunity. Said another way, by using a buy limit order the investor is guaranteed to pay the buy limit order price or better, but it is not guaranteed that the order will be filled.
Buy Limit Order
- A buy limit order guarantees the specified price or lower.
- A buy limit is not guaranteed to be filled.
- Buy limit orders control costs but can result in missed opportunities in fast moving market conditions.
- A buy limit order isn't better than a buy stop limit order or a market order. All order types are useful and have their own advantages and disadvantages.
Benefits of a Buy Limit Order
A buy limit order ensures the buyer does not get a worse price than they expect. Buy limit orders provide investors and traders with a means of precisely entering a position. For example, a buy limit order could be placed at $2.40 when a stock is trading at $2.45. If the price dips to $2.40, the order is automatically executed. It will not be executed until the price drops to $2.40 or below.
Another advantage of a buy limit order is the possibility of price improvement when a stock gaps from one day to the next. If the trader places a buy order at $2.40 and the order is not triggered during the trading day, as long as that order remains in place it could benefit from a gap down. If the price opens the next day at $2.20, the trader will get the shares at $2.20 as that was the first price available at or below $2.40. While the trader is paying a lower price than expected, they may want to consider why the price gapped down so aggressively, and if they still want to own the shares.
Unlike a market order in which the trader buys at the current offer price, whatever that may be, a buy limit order is placed on a broker’s order book at a specified price. The order signifies that the trader is willing to buy a specific number of shares of the stock at the specified limit price. As the asset drops toward the limit price, the trade is executed if a seller is willing to sell at the buy order price.
Since a buy limit sits on the book signifying that the trader wants to buy at that price, the order will be bid, usually below the current market price of the asset. If the price moves down to the buy limit price, and a seller transacts with the order (the buy limit order is filled), the investor will have bought at the bid, and thus avoided paying the spread. This may be helpful for daytraders who seek to capture small and quick profits. For large institutional investors who take very large positions in a stock, incremental limit orders at various price levels are used in an attempt to achieve the best possible average price for the order as a whole.
Buy limit orders are also useful in volatile markets. Assume a trader wants to buy a stock, but knows the stock has been moving wildly from day to day. They could place a market buy order, which takes the first available price, or they could use a buy limit order (or a buy stop order). Assume the stock closed yesterday at $10. The investor could place a buy limit at $10, assuring they won't pay more than that. If the stock opens the next day at $11, they won't be filled on the order, but they have also saved themselves from paying more than they wanted to.
Disadvantages of Buy Limit Orders
A buy limit order does not guarantee execution. Execution only occurs when the asset's price trades down to the limit price and a sell order transacts with the buy limit order. The asset trading at the buy limit order price isn't enough. The trader may have 100 shares posted to buy at that price, but there may be thousands of shares ahead of them also wanting to buy at that price. Therefore, the price will often need to completely clear the buy limit order price level in order for the buy limit order to fill. The earlier the order is put in the earlier in the queue the order will be at that price, and the greater the chance the order will have of being filled if the asset trades at the buy limit price.
Buy limit orders can also result in a missed opportunity. The price of the asset has to trade at the buy limit price or lower, but if it doesn't the trader doesn't get into their trade. Controlling costs and the amount paid for an asset is important, but so is seizing an opportunity. When an asset is quickly rising, it may not pull back to the buy limit price specified before roaring higher. Since the trader's goal was to catch a move higher, they missed out by placing an order that was unlikely to be executed. If the trader wants to get in, at any cost, they could use a market order. If they don't mind paying a higher price yet want to control how much they pay, a buy stop limit order is effective.
Some brokers charge a higher commission for a buy limit order than for a market order. This is largely an outdated practice, though, as most brokers charge a flat fee per order, or charge based on the number of shares traded (or dollar amount), and don't charge based on order type.
Buy Limit Order Example
Apple stock is trading at a $125.25 bid and a $125.26 offer when an investor decides they want to add Apple to their portfolio. They have several choices in terms of order types. They could use a market order and buy the stock at $125.26 (assuming the offer stays the same, and there are enough shares at that price to fill the market buy order), or they could use a buy limit at any price of $125.25 or below.
Maybe the trader believes the price will fall slightly over the next several weeks, so they place a buy limit order at $121. If Apple stock trades down to $121 (ideally $120.99 to assure the order is filled) then the investor will own shares at $121, a significant savings from the $125.25/26 price the investor first saw.
The price may not drop to $121, though. Instead, it may move from a $125.25 bid up to $126, then $127, then $140 over the next several weeks. The price rise the investor wanted to participate in has been missed because their buy limit order at $121 was never executed.
If an investor expects the price of an asset to decline, then a buy limit order is a reasonable order to use. If the investor doesn't mind paying the current price, or higher, if the asset starts to move up, then a market order to buy stop limit order is the better bet.