Limit Orders

I l @ ve RuBoard

Limit orders are perfectly named, as they imply that a limit has been placed on the price the investor is willing to pay to purchase the stock or that a minimum price has been given at which the investor will sell the shares he or she currently owns. In addition, limit orders are always placed at a different price than that at which the stock is currently trading ”higher for sales and lower for buys. This is known as away from the market.

Plain English

Limit orders instruct a broker to purchase stock at a price lower than the current market price or to sell stock at a price higher than the current market price.

Let's suppose that you want to buy 100 shares of XYZ Company, which at the moment is trading for $10 per share. You are convinced, because of something you read in the newspaper, that the price of the stock is about to drop ”XYZ is being sued for copying ABC Com-pany's patent, let's say. You are an attorney who knows that ABC Company's case won't stand up in court . Therefore, you figure that the initial price of $10 per share of XYZ Company will drop when people get the bad news and then will go up again when people get the later news that the case has been dismissed. You give your broker a buy limit order.

The buy limit order tells your broker to purchase XYZ Company's stock only when it drops to a certain price, which in your case is $8. You will also probably want to use a notation to tell your broker how long you are willing to wait for the price to drop: a day, a week, or a month. You do this, of course, believing that the value of the stock will eventually go back up. So your investment strategy is to buy as if the stock is on momentary sale.

On the other hand, if you currently own XYZ stock valued at $8 and you believe its price is going to go up and then later drop, you will want to give your broker a sell limit order. By doing so, you tell the broker to sell your stock only if the price rises to $10. Of course, you are assuming that the price of XYZ stock will later drop and remain below the price of $10. This is called getting out when the going's good.

CAUTION

Be warned that the type of timing necessary to successfully manipulate limit orders doesn't come quickly or easily. New investors are strongly urged to consider the pitfalls in this type of trading before attempting it.

I l @ ve RuBoard