Knowing our limits is important in our day to day living. It could be about limiting our junk food intake, how late we stay up, or how much we spend on entertainment. Whatever it is, understanding our limits in situations we face will help to keep us out of trouble. And of course, investing is no different. This week, we explore the use of “limit orders” and how to utilize them to keep you out of financial trouble and make you a savvier investor.
So, what is a limit order? It’s setting a specific price at which you choose to buy or sell a security. The order will only be filled at that specific price or better. For example, let’s use EREV – the Evermore Retirement 2045 ETF. Placing a buy limit order at $19.50 means the trade must be executed at $19.50 or less. So, while the buy limit order remains open, if EREV happens to trade at $18.95, you would end up buying it at this favourable price. Conversely, if the price rises above $19.50, no execution will occur – hence the limit. Similarly, if you wanted to sell the units with a limit order of $19.50, the trade would execute at $19.50 or higher. So, if the price drops below $19.50, no execution will occur because it’s lower than your limit price. Limit orders don’t guarantee full execution, but they do help you better manage the entry or exit prices you want.
Limit orders are different from market orders. A market order is executing a buy or sell order at whatever the current market price is. Since you can get any price, looking at the bid-ask spread is important. The bid price is the maximum price a buyer is willing to pay for that security while the ask price is the minimum price a seller is willing to take for that security. Generally, the narrower the spread, the better the liquidity - which is what you want. For example, let’s say EREV is trading at $19. If you place a market order to buy EREV during trading hours, the order would likely be filled at around $19 because the bid ask spread of EREV is only $0.02. This will not be true for every security out there so look at the bid-ask spreads before executing at market. Regardless, the order execution will almost always be filled since the transaction is conducted at whatever the current market price is.
One thing to note is if you place a market order outside of trading hours, it would likely be executed at the open of the next trading day. Executing at market open or market close could mean unfavourable prices. At the start of the trading day, the underlying securities and ETF models are cranking up and may not reflect the appropriate fair value immediately. There could also be extremely high or low prices other market participants have placed which could catch unsuspecting investors executing market orders. The bottom line is it’s simply best to avoid trading right at market open or close but if you need to, use a limit order.
In short, the use of limit orders when buying or selling securities and avoiding transacting at the open or close are two tips we recommend to investors. While there are other sophisticated execution orders available, these are two simple strategies to keep you out of trouble and make you savvier.
Commissions, trading fees, management fees and expenses all may be associated with an investment in exchange traded funds (ETFs). Please read the prospectus before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.