Limit Order Strategy (Backtest And Example)

Last Updated on October 10, 2022 by Oddmund Groette

Different order types can result in vastly different outcomes, which is why it is important to understand the type of order you use. If you want your order to be filled at your specified price, go for a limit order. But what is a limit order?

A limit order is an order to buy or sell a security at a specific price or better. It comes with a specification of the maximum price to be paid or the minimum price to be received, and this is known as the “limit price”.

In this post, we take a look at the limit order strategy, and at the end of the article, we make a backtest of a limit order strategy.

What is a limit order?

A limit order is an order to buy or sell a security at a specific price or better. It comes with a specification of the maximum price to be paid or the minimum price to be received, and this is known as the “limit price”. The limit order is usually placed away from the current market price, and it sits there waiting for the price to reach the specified level.

When the order is filled, it will only be at the specified limit price or a better price. So, it gives the trader more control of the price they get in at. However, there is no assurance of its execution, as the price might not get to the specified price, resulting in missed trading opportunities. While a limit order may be appropriate when you think you can get in at a better price, you may end up missing the trade entirely.

It is also important to note that for many brokers, a limit order is usually valid for either a specific number of days until the order is filled, or until the trader cancels the order.

Types of limit orders: buy limit order and sell limit order

There are two types of limit orders: the buy limit order and the sell limit order. A buy limit order is an order to buy a security at the specified limit price or lower. The order is placed below the current market price with the hope that the price fall lower to its level and then reverse.

A sell limit order, on the other hand, is placed above the current market price and can only be executed at the specified limit price or higher.

An example of a limit order (buy and sell limit order)

Let’s say Apple Inc’s (AAPL) stock is trading around $150 per share and you believe it could fall to $130 in the coming days or weeks. You can set a buy limit order to purchase the stock at $130 per share, good ’til canceled. The order will remain open until the stock reaches the specified limit price, and your order gets filled at $130 or lower, or you cancel the order.

Similarly, if you want to sell Microsoft Corp.’s (MSFT) stock but think that its current price of $237 per share is too low and believe that it could rise to $300 per share in the coming weeks, you can set a sell limit order at $300. When the price rises to that level, your order will be filled at $300 or higher.

Which is better stop or limit order?

It depends on what you want:

A limit order will only be filled at the specified limit price or better; whereas once a stop order triggers at the specified price, it will be filled at the prevailing price in the market, so it could get filled at a worse price.

The limit order gives you control of the price to get in at but, there is no assurance of execution with limit orders. It may not be triggered before the market turns and makes the anticipated move, making you miss the move. On the other hand, the stop order allows you to get in along the momentum. If it doesn’t trigger, it means the expected move never happened and you won’t miss out on anything.

Limit orders can be seen in the order book, so the market can see your order and the anticipated move. Stop orders can’t be seen by the market, allowing you to mask your entry if you place huge orders.

Limit order strategy backtest

Coming soon.

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