What are limit orders in trading, and how do they work from the technical perspective?

Limit orders are about control and precision. They enable traders to take control of their trading and only enter the market when specific conditions are met. Limit orders are especially popular among experienced traders who want to buy or sell at a specific price or better. While market orders execute immediately, limit orders wait for a specified price. For securing entry and exit prices and avoiding slippages, limit orders can provide real-world benefits. Let’s define what a limit order is and explain its anatomy to see how exactly these orders work and whether you can use them in your trading.

The anatomy of a limit order: How it really works?

There are several different order types available, making it easier for traders to execute their strategies. There are market orders, stop orders, and limit orders. The market order allows immediate execution of trading positions, which is flexible but can be useless when you need to time your entries for a specific price or time. Stop orders are executed at a specific price. For example, stop loss (SL) and take profit (TP) orders are stop orders. Here is a guide to SL and TP orders, as we only focus on limit orders in this text. SL and TP orders are critical in financial trading as they enable traders to control their losses and targets.

What is a limit order

A limit order is a conditional trade instruction for your platform that executes only at a specific price or better. Unlike market orders, which are focused more on speed, limit orders are designed for precision. There are buy and sell limit orders.

Buy Limit Order

Buy limits are placed below the current market price, meaning price has to fall at your limit price for this order to be triggered. For example: If Tesla trades at 210 USD, a buy limit order at 200 dollars would wait for the price to drop to $200 before executing.

Sell Limit Order

A sell limit is placed above the current price and is executed when the price rises to your predetermined level. For example, if Tesla trades at 210 USD, a sell limit order at 220 would be triggered only if the price rises to that level.

While limit orders allow traders to be precise, they are not guaranteed to be filled. If the price does not go to the level where the order is placed, the order won’t be triggered.

Technical execution: How do exchanges process limit orders?

Exchanges employ sophisticated infrastructure to process all orders, including limit orders. When you click on sell or buy limit, several things start to happen in the background right away. The order is placed in the order book and waits for the right price to get filled (executed). Let’s follow each of these steps.

Order book dynamics

Order book priorities time and price orders queued first by price will get filled first. For example, a buy limit at 200 will be executed before 199 (bid). At identical prices, earlier submissions execute first. This ensures transparency, speed, and honesty.

Limit orders can also be filled partially (partial fills). If a trader places a buy limit for 100 shares at 50 bucks, but only 50 are available, the order partially fills, leaving 50 shares pending. This almost never happens in Forex markets where the liquidity is very deep, but it is worth keeping in mind for stock traders. 

Matching engines

Algorithms have transformed modern trading, enabling a quick scan of the order book to pair compatible bids and asks. HFT (High-frequency trading) firms can exploit nanosecond-level latencies to jump the queue and secure priority by updating prices faster than retail traders. However, if a trader is trading 5-minute charts and beyond, this is never an issue.

Institutional traders often use various methods to ensure their orders execute before others, like colocating their servers near exchange centers to reduce latency. This can cause retail orders to face some delays, but again, this is not an issue for retail traders who are trading on FX markets, and slippage is relatively low.

Limit order types

There are several limit order types such as GTC, IOC, FOK, and Post-Only. The GTC or Good-Til-Canceled order remains active indefinitely, which is ideal for long-term strategies. The FOK or Fill-or-Kill limit order requires full execution or total cancellation, which is typically used in large-block trades. The Post-Only limit order ensures the order adds liquidity  (avoids take fees), which is super useful for algorithmic trading strategies.

Benefits of using limit orders

As we have mentioned, limit orders are perfect for precision. When using limit orders, price is under our control, meaning we eliminate slippage in stable or sideways markets. This ensures near perfect entries.

Because of precision, limit orders also enable traders to make profits from small price gaps and algorithmic trading. As a result, limit orders can be useful for scalpers and automated trading system users.