Choosing the limit when making a limit order?

Question

I am a long term investor that periodically (several times per month) adds to existing positions. I usually place my orders for stocks before the market opens. I use limit orders primarily to protect myself from price rises that would make the order cost more than the cash I have in my account.

What is a good method for choosing the limit on a limit order? Should I genuinely provide the maximum amount I would be willing to pay for the stock? Right now I am usually setting the limit right at the ask in the bid-ask spread (at the close of the previous day). I am concerned about repeatedly incurring unnecessary transaction costs.

When providing an answer, please take into account the fact that these orders are usually happening before the market opens.

Answer 1

Should I genuinely provide the maximum amount I would be willing to pay for the stock?

Never. Isn't that the whole idea of the limit order. You want a bargain, not the price the seller wants. And when the market opens it is volatile at the most, just an observation mayn't be correct. Let it stabilize a bit. The other thing is you might miss the opportunity. But as an investor you should stick to your guns and say I wouldn't buy any higher than this or sell any lower than this. As you are going long, buying at the right price is essential. You aren't going to run away tomorrow, so be smart.

Probably this is what Warren Buffet said, it is important to buy a good stock at the right price rather than buying a good stock at the wrong price.

There is no fixed answer to your question. It can be anything. You can check what analysts, someone with reputation of predicting correctly(not always), say would be the increase/decrease in the price of a stock in the projected future. They do quite a lot of data crunching to reach a price. Don't take their values as sacrosanct but collate from a number of sources and take an average or some sorts of it. You can then take an educated guess of how much you would be willing to pay depending the gain or loss predicted.

Else if you don't believe the analysts(almost all don't have a stellar reputation) you can do all the data crunching yourself if you have the time and right tools.

Answer 2

Wouldn't this be part of your investing strategy to know what price is considered a "good" price for the stock? If you are going to invest in company ABC, shouldn't you have some idea of whether the stock price of $30, $60, or $100 is the bargain price you want? I'd consider this part of the due diligence if you are picking individual stocks. Mutual funds can be a bit different in automatically doing fractional shares and not quite as easy to analyze as a company's financials in a sense.

I'm more concerned with the fact that you don't seem to have a good idea of what the price is that you are willing to buy the stock so that you take advantage of the volatility of the market.

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ETFs would be similar to mutual funds in some ways though I'd probably consider the question that may be worth considering here is how much do you want to optimize the price you pay versus adding $x to your position each time. I'd probably consider estimating a ballpark and then setting the limit price somewhere within that. I wouldn't necessarily set it to the maximum price you'd be willing to pay unless you are trying to ride a "hot" ETF using some kind of momentum strategy. The downside of a momentum strategy is that it can take a while to work out the kinks and I don't use one though I do remember a columnist from MSN Money that did that kind of trading regularly.

Answer 3

There are a couple of things you could do, but it may depend partly on the type of orders your broker has available to you.

Firstly, if you are putting your limit order the night before after close of market at the top of the bids, you may be risking missing out if bid & offer prices increase by the time the market opens the next day. On the other hand, if bid & offer prices fall at the open of the next day you should get your order filled at or below your limit price.

Secondly, you could be available at the market open to see if prices are going up or down and then work out the price you want to buy at then and work out the quantity you can buy at that price. I personally don't like this method because you usually get too emotional, start chasing the market if prices start rising, or start regretting buying at a price and prices fall straight afterwards.

My preferred method is this third option. If your broker provides stop orders you can use these to both get into and out of the market. How they work when trying to get into the market is that once you have done your analysis and picked a price that you would want to purchase at, you put a stop buy order in. For example, the price closed at $9.90 the previous day and there has been resistance at $10.00, so you would put a stop buy trigger if the price goes over $10, say $10.01. If your stop buy order gets triggered you can have either a buy market order or a limit order above $10.01 (say $10.02). The market order would go through immediately whilst the limit order would only go through if the price continues going to $10.02 or above.

The advantage of this is that you don't get emotional trying to buy your securities whilst sitting in front of the screen, you do your analysis and set your prices whilst the market is closed, you only buy when the security is rising (not falling). As your aim is to be in long term you shouldn't be concerned about buying a little bit higher than the previous days close. On the other hand if you try and buy when the price is falling you don't know when it will stop falling. It is better to buy when the price shows signs of rising rather than falling (always follow the trend).

Answer 4

I actually get what your asking here. You just want to know how to price your orders so as to avoid overpaying. Also, I'm guessing since you buy mostly ETFs the whole post-market discussion is basically irrelevant.

If you're truly buying BEFORE the market opens then you're buying pre-market so if you check the post-market price on most ETFs the night before and place a limit order for between .02-.05 cents above the last price you should be totally fine. If you, for some reason miss your entry (it jumps .06 cents before your order gets executed) I would wait until the next night and try again.

Most ETFs move slowly and don't jump as often or violent as other stocks on the morning.