A limit order to buy (also referred to as a buy limit order) is a trading strategy for purchasing an asset at a set price. It not a guaranteed purchase, but an attempt or bid to purchase an asset.
In this article, we explain what limit order to buy is, and what kind of investment strategy it is. To make this investment approach clear, we’ll compare and contrast it to other kinds of asset acquisition.
More specifically, a buy limit order is an order to purchase an asset at or below a specified price. This allows traders to set the price that they are willing to pay for an asset. It also guarantees that an investor will not pay more than they want to. There’s also a chance they might pay less for the stock if the asking price drops.
The crucial takeaway from a limit order to buy is that it’s a good strategy to acquire a volatile but valuable stock at a specific price. However, it is not a strategy for a quick and assured purchase.
A limit order to buy is an investment strategy. This means that the trader is only going to buy a specific number of shares of the stock at the specified limit price. Therefore, the trade can only be completed if the seller is willing to agree to the buy order price.
Why this strategy is useful
This can be a useful strategy because it ensures that a) you are only spending what an investor is willing to spend, and b) if the stock you are watching matches the buy limit, your purchase is guaranteed.
This strategy can be used when bidding on a volatile but valuable stock. So, when the price fluctuates, the investor can acquire more of the asset at the lower rate. This ultimately limits the overall cost while ensuring future gains.
A crucial point to grasp for this strategy is that the purchase rate is set, but the actual purchase of the stock is not certain.
The purchase of the asset is contingent on the buy limit and that the price is to equal or less than the buy limit. Thus the guarantee is only that the investor will not pay more than the agreed upon price.
While there are some obvious limitations to this tactic, there are several reasons that a limit to buy is useful. Limits can be helpful in volatile markets. If the stock value has changed dramatically from one day to the next and a trader wants to buy a stock, they could place a buy limit order and get more for their dollar.
Say you want to buy Stock-A at $25. The buy limit ensures that the transaction will only be completed if the stock drops to $25 or lower. In order to better understand how this strategy works, I will compare a limit order to buy to a few other common investment strategies.
Before we go any further, it will be helpful to sort out a few concepts that are important for understanding investment strategies. This will help one to learn what is the best approach to asset acquisition for the individual investor.
Useful Terminology: Slippage and Spread
Slippage typically refers to futures and the difference between the estimated and actual transaction costs. It is the difference between estimated transactions costs and actual transactions costs.
Futures are a legal agreement to buy or sell an asset at a decided price, at a specified future date. The difference is usually a result of changes in the price of an asset or spread (which I will explain shortly). Commission costs also contribute to slippage.
Slippage costs can occur for a variety of reasons, such
- A broker’s mistake
- Reduced liquidity
- Increased transportation costs related to the commodity
Many brokerages use algorithmic trading to avoid and manage the costs of slippage. Algorithmic trading is a way to fulfill a large order that is too large to fill all at once. Instead, small parts of the order are sent out to the market over time.
Spread is the difference in the price of an asset that a buyer is willing to pay and the lowest price that is accepted by the seller. For example, if an asset sells for more than one purchased it at, the profit from the sale is called a spread.
Spread also refers to the difference between the highest bid and the lowest offer for a specific security.
Spread can occur as a result of a gap. A gap typically occurs when current events or new information causes a surge of buyers or sellers into a specfific security. A gap then is the outcome of a significant change in value very quickly. This means that the price opening will be significantly higher or lower than it was when it closed on the previous day.
Gaps can be indicative of the start of a new trend, or it can indicate the end of an existing trend.
Understanding Investment Strategies
There are several ways to structure the purchase of an asset that
To understand the advantage and disadvantages of limits, it is helpful to understand other forms of payments and asset acquisition.
A market order is the most straightforward purchase of an asset and typically has the lowest brokerage commission. It is an immediate purchase at the current market price, which sets it apart from a limit order to buy.
For a market order, the trader buys the stock at the price that is currently on offer. Market orders are used when the priority is acquiring a stock rather than buying the stock at a specific price. Therefore, with market orders, there is no control over the price but is more concerned with the priority of buying the asset.
Because of the priority of
Market orders are considered the best way to buy or sell a security at the best available price in the current market. This is because it is the quickest and most reliable method of ensuring that the investor enters or exits a trade.
A Stop Order:
A stop order is a kind of conditional order
Stop orders are most common for acquiring stock and futures that trade on an exchange. They are usually subject to the same fees as market orders and are also subject to slippage because the purchase is not made right away. Once the desired asset reaches the stop price, it is processed the same way as a typical market order.
As you can see, there are many approaches to acquiring new assets and strategies to attempt to get the asset you want at the price you want it.
One of the differences between various kinds of order are the brokerage fees. Some brokers will charge a higher commission for a limit order to buy than they will for a market order. However many brokers simply charge a flat fee per order, or just use commission-based fees. Such fees are really going to vary between brokers.
Since a buy limit signifies that the trader wants to buy at a set price, the order will be put forward only as a bid. In this case, the bid is usually below the current market price of the asset.
However, if and only if the price drops to meet the buy limit price will the buy limit order is executed. That means that the investor will have bought the asset at the bid. In doing so they avoided paying the spread.
To learn about Stop Limit Orders, read here.
Why is a limit order to buy a good investment strategy to acquire assets?
Buy limits can be useful to day-traders who hope to capture small profits quickly. Particularly if you are interested in assets that you know are valuable but volatile.
On the other hand, for large institutional investors who have large holdings of stock, limit orders are a strategy for trying to achieve the best possible average price for the total purchase order. In layman’s terms, it’s more bang for your buck!
The primary reasons that limit orders are so appealing are
Disadvantages of Buy Limit Orders
Remember, a buy limit order does not guarantee that an investor will acquire the asset. This is because the execution of the order only occurs when the asset’s price drops down to the limit price.
Therefore, a buy limit order price also is not enough to ensure a purchase. For instance, a trader may want to buy 100 shares at $25. However, there may be thousands of shares ahead of her order, and they also want to buy at $25. Therefore, the earlier the order is made, the earlier in the queue the order will be at $25.
So, the conditions for a successful purchase using a limit order to buy are:
- a) the buy limit needs to be at or more than the price of the asset
- b) the buy order is early enough in the queue that if the price conditions are met, the order is processed.
As a result of the conditions of buy limit orders, there is a potential that you might miss out on an investment opportunity.
Controlling costs and the payment amount for an asset are useful and necessary. But it is also necessary to seize opportunities. If an asset’s value is quickly rising, it may not come back down to the buy limit price before it continues to increase. So by setting a buy limit that is too low, the trader will not profit if the stock continues to rise, which was the original goal.
Conclusion and Review
Here’s what you need to remember about limit orders to buy, or buy limit orders:
A buy limit order guarantees that an asset is purchased if and only if it meets the specified price or lower. It is therefore different from a straight forward market order because it does not guarantee the investor acquisition of the stock.
Remember, a limit to buy order looks something like this: you want to buy Stock-A if and only if it is $25 or lower then you can use a buy limit order. So if the Stock-A is $24 the purchase will go through. But if the stock is $25.01 it will not.
A buy limit is not a order that is a guaranteed purchase; a buy limit order is the order to buy ONLY if Stock-A is $25 or lower.
What’s more, is there are no guarantees that the asset will ever match $25. So this strategy does not ensure the purchase of the stock, or even that the price of the asset will reach $25.
Finally, there may be good reasons to use a buy limit order, but there are also downsides to this method. Buy limit orders control spending costs because of the fixed purchase price. But the limitations can result in lost opportunities in fast moving market conditions. Additionally, the investment strategy used for stock acquisition not only depends on the investor but also on the nature of