Buying and selling stocks is a respected form of gambling, many people think. You the stockholder never really know for sure whether that hot stock that you buy is going to go up or down. You can be reasonably certain of the direction of its share price, based on market indicators or, in some cases, inside knowledge. Indeed, a large number of people buy stock knowing full well what is going to happen in the short run. Long-run behaviors, however, are much more difficult to predict.
Many investors have a target level for the price of a stock when they decide to buy or sell. For example, you might arrive at the figure of $50 a share, which is all you want to spend on a certain stock. Once you decide that you won’t buy if the share goes above $50, then you have set $50 as your limit price for that stock. Especially if you have a limited amount of money to spend, setting a limit price is a good idea.
The limit price is not just for you, though. It is, most importantly, for the broker or the person who will buy the stock for you. Once this person knows your limit price, he or she is bound to honor your wishes and not buy if the stock passes this price.
This works in the other direction as well. You might decide that you don’t want to buy a stock if the share price goes below a certain level. Some stocks are not worth buying when the price falls too low. Such an eventuality could occur after some especially bad news for the company.
It’s not just buying, either. A limit price can come in handy for selling stocks as well. You the seller can set a price over which you don’t wish to sell. If you have a hot stock, one that is rising on news of good returns and profits, you probably don’t want to sell that stock. You might decide that $80 is your limit price. Once the stock price reaches $80, you hold onto it.
You might also, for whatever reason, set a limit price under which you wouldn’t sell, either. Some stocks on the way down suddenly become attractive for bargain-hunters. A stock that usually trades at between $20 and $40, but is suddenly trading at $6, might get snapped up by someone looking to make a fast profit. In that scenario, you might set your limit price at $10.