Trading tools and terminologies can be confusing for the average person, be it in the stock market or the 24/7 volatile cryptocurrency market. But it doesn’t have to be – if you’re looking for greater control over your trades, consider using limit orders to cap the buying or selling price of a cryptocurrency. No idea how does a limit order work? Fear not, we’ll go over what it is and how it works in detail, so that you’ll be able to grasp and make use of it in no time!
Limit Order Vs. Market Order
A limit order is an order that you place on the order book with a specific limit price. The limit price is determined by you. The trade will only be executed if the market price reaches your limit price (or better). Therefore, you may use limit orders to buy at a lower price or to sell at a higher price than the current market price.
Unlike market orders, where trades are executed instantly at the current market price, limit orders are placed on the order book and are not executed immediately. In most cases, limit orders result in lower fees because you trade as a maker instead of taker.
How Does a Limit Order Work?
A buy-limit order is transacted at the limit price or lower, while a sell-limit order is executed at the limit price or higher. However, there is no guarantee that a limit order will be executed since a limit order will only be filled if the market price of the asset reaches the limit price. If the market price never reaches the limit price, the instructed trade will remain unfilled on the order book.
For example, you want to sell 5 ETH at $1,300, and the current price is $1,200. You can place an ETH sell limit order of $1,300. When the ETH price reaches the target price or above, your order will be executed depending on market liquidity. If there are other ETH sell orders placed ahead of yours, the system will execute those orders first. Your limit order will be filled afterward with the remaining liquidity.
Although limit orders don’t guarantee that an order will be fulfilled, they are useful in ensuring that the user does not pay more or receive less than the specified price. A limit order can also be placed for up to a few months typically, but it depends on the crypto exchange used.
When Are Limit Orders Used?
Unlike market orders, where trades are instantly executed at the current price, a limit order gives the user more control over the price at which the trade is executed. Since limit orders are placed in advance and carried out automatically when the conditions are met, there would no longer be a need to watch the market 24/7 or worry about missing a buy or sell opportunity while asleep.
In the following instances, one can utilize a limit order:
You want to buy at a specific price below the current market price, or sell at a specific price above the current market price;
You are not in a hurry to buy or sell immediately;
You want to lock unrealized profits or minimize potential losses;
You want to split your orders into smaller limit orders to achieve a dollar-cost-averaging (DCA) effect.
Another thing to note is that even if the limit price is hit, the order might not always be filled as it all depends on the market conditions and existing liquidity. In some cases, the limit order might only be partially filled.
Stop-loss Vs. Limit Orders
There are different types of orders you can use when trading crypto, such as limit, stop-loss and stop-limit orders.
A stop-loss order is a market order that triggers when the market reaches your stop price. It is an order to buy or sell a cryptocurrency at the market price once its price hits the stop price set by the user. Once triggered, a stop-loss order turns into a market order and executes at the current market price. If the stop price isn’t reached, the order will not be executed.
Sell stop orders can be used to minimize potential losses in case the market moves against your position. They can also be used as a “take-profit” order to exit a position and protect unrealized profits. Buy stop orders can also be used to enter the market at a lower price.
The difference between a limit order and a stop-loss order is that the former will execute at the limit price set (or better), while the latter will execute (as a market order) at the current market price. But it is worth noting that if the market price changes too quickly, your order might be filled at a price that differs significantly from the trigger price.
Stop-limit Vs. Limit Orders
A stop-limit order combines the features of a stop-loss and a limit order. Once the stop price is reached, it will automatically trigger a limit order. The order will then execute if the market price matches the limit price or better. If a user does not have time to monitor his portfolio closely, stop-limit orders can be used to limit the losses incurred on a trade.
When placing a stop-limit order, the user has to define two prices: the stop price, and the limit price. The difference between stop-limit orders and limit orders is that the former will only place a limit order if the stop price is reached, while the latter will be placed instantly on the order book.
For example, if ETH is trading at $1,500 and you place a sell stop-limit order with the stop price at $1,490. This means that if ETH drops to $1,490, the system will automatically set up a sell limit order with the limit price you specified (for example, $1,485) or higher. However, there is no guarantee that your orders will be filled. If the market moves too fast, there is a chance your order will remain unfilled.
Stop-limit Vs. Stop-loss Orders
Both stop-limit and stop-loss orders are triggered according to your stop price. But the difference lies in the type of order created after the stop orders are triggered – the stop-limit order will create a limit order, while the stop-loss will create a market order.
Closing Thoughts
A limit order can be a great trading tool when the user wishes to buy or sell a cryptocurrency at a better price than the current market is pricing it at. It is primarily used to maximize unrealized gains or limit potential losses. But prior to choosing an order type, users should understand how does a limit order work and how it compares to the various order types stated above. From there, users can evaluate how each one plays into their overall portfolio and trading strategy.
