Limit Orders

If you're going to buy stocks through a broker instead of an individual trading account, you will need to know the definition of a limit order. A limit order is a way of limiting your risk by having a plan about when to buy or sell individual stocks. When you have a limit order in effect, if your stock takes a tumble, it doesn't have to fall all the way to the bottom of the chart before you can get your money out. People use limit orders to control the amount they lose on a particular stock and also to determine when they will buy other stocks.

If you buy a stock of $16 a share, it can be heartbreaking to watch it decline. You have two choices: hang on like grim death and pray that it will recover; or sell it and get out while you still have some of your original investment left. Whether to stay and play or run away should depend on the history and reliability of the company behind the stock. If your stock's value is in decline because of something that is negative but won't really affect the success of the company in the long run, you may as well wait it out because chances are, the stock price will rise again once the perceived crisis is over. If your stock's value is in decline because the dot-com that issued it has been evicted from its building, you'd better get out while you can. What I meant to say here is that if an investment was a poor choice in the first place (its price was way over its book value, fore example) and you knew it was risky, that drop in price may be fatal to the company. If it's a big, strong company and the price dropped because it changed CEOs or had a less-than profitable quarterly earnings report, you're probably not witnessing its demise but a single up or down in a long and basically healthy life cycle.

So, if you bought your $16 shares and then realized your investment was probably but not definitely a bad one and you're willing to wait a little just in case the company manages to pull itself out of the fire, you may decide to tell your broker not to sell until the price drops to (or below) $14.50. As soon as the stock price hits $14.50 or lower, your shares will be sold and you will have lost $1.50 a share instead of maybe $5 or even all of it. What you've done is called a sell stop or a stop sell or a stop loss order.

Or, your $16 stock is doing fine, but you think it may be a little too fine and will soon naturally adjust downward. You want to sell it, but maybe not today because you think it may ride at the higher price a little longer. You can tell your broker to sell when the price hits $18.75 because past that, you think there's a good chance you'll get caught when it drops. You want to maximize your profits, and get out at the top of the ride if at all possible. This is called a buy limit order.

Limit orders are often used by people who have many investments and don't want to have to keep track of them all the time. Forex or foreign exchange traders are just one example of people who use limit orders.

When you place a limit order, it's either for the day only ("day order") or in effect until you say so (GTC, or good 'til canceled).

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