As you learnt in The Basics , selling short is an extremely speculative practice that can, theoretically, lead to unlimited losses.
Here’s how it works: You think that Company ABC is grossly overvalued. Management is terrible, financial condition is deteriorating, the sales outlook is pitiful, and, you believe, the stock price does not fully reflect these apparent realities. You are convinced the stock is going to fall substantially from its current price of $10 per share.
A limit order allows you to limit either the maximum price you pay or the minimum price you are willing to accept when buying or selling a stock.
The primary difference between a market order and a limit order is that your broker cannot guarantee that the latter will be executed.
Imagine you want to buy 300 shares of U.S. Bank stock. The current price is $29 per share. You do not want to pay more than $27.50, so you place a limit order set to execute at $27.50 or less. If the stock falls to that price, your order should be executed.
There are three considerations you should take into account before placing a limit order:
1. The stock price may never fall (or rise) to the limit you’ve established. As a result, your order may never be executed.
2. Limit orders are executed by your broker in the order they are received. It is possible that the stock you are interested in buying (selling) will reach your limit price yet your trade will not be filled because the price fluctuated above (below) your limit before the broker could get to your order.
3. If there is a sudden drop in the stock price, your order will be executed at your limit price. In other words, imagine the stock you want is trading at $50 per share. You have a limit order placed at $48 per share. The CEO resigns, and in a single session, the stock plummets to $40 per share. As the security was falling in price, your order was executed. You are now sitting on a loss of $8 per share.
If you would like to make a comment, please fill out the form below.
