SIE PREP | FINANCIAL REGULATION COURSES
A stop-limit order is a conditional trading instruction that executes as a limit order once a specified stop trigger price is reached or breached.
A limit order is an instruction to a broker-dealer to buy or sell a security at a specified price or better — meaning a buy limit order will execute only at the limit price or lower, and a sell limit order will execute only at the limit price or higher. Unlike a market order, which executes immediately at whatever price the market currently offers, a limit order sacrifices certainty of execution for certainty of price, guaranteeing that if the trade executes it does so at acceptable terms, while accepting the risk that the market may never reach the specified price and the order may go unfilled. Limit orders are among the most heavily tested order types on the SIE and Series 7 examinations.
Buy Limit Orders — The Mechanics
A buy limit order instructs the broker to purchase the security at the limit price or at any lower price. An investor placing a buy limit order at fifty dollars is willing to pay up to fifty dollars per share but will not pay more. If the stock is currently trading at fifty-three dollars, the order sits unexecuted in the broker's order management system, waiting for the market price to fall to fifty dollars or below before triggering execution. If the price never reaches fifty dollars, the order expires unfilled at the end of the day — or at the end of the specified time period for a good-till-cancelled order.
The economic logic of the buy limit order is straightforward — the investor believes the stock is worth buying, but only at a price reflecting an adequate margin of safety or an acceptable entry point. Paying fifty-three dollars for a stock the investor values at fifty dollars would immediately produce a loss relative to the investor's assessment of fair value.
Sell Limit Orders — The Mechanics
A sell limit order instructs the broker to sell the security at the limit price or at any higher price. An investor holding a stock currently trading at forty-seven dollars who places a sell limit at fifty dollars is unwilling to sell below fifty. The order sits unexecuted until the market price rises to fifty dollars or above. If the stock never reaches fifty dollars and instead declines further, the investor retains the position and continues to bear the risk of further price declines.
The sell limit order is commonly used to take profits at a predetermined target price — the investor buys a stock at forty dollars believing it is worth fifty and places a sell limit at fifty to capture the anticipated gain automatically without having to monitor the price continuously.
Price Improvement on Limit Orders
A key examination point is that a limit order may execute at a price better than the limit specified. If an investor places a buy limit at fifty dollars and the market price falls to forty-eight dollars, the order may execute at forty-eight dollars rather than fifty — the investor receives price improvement of two dollars per share.
This occurs when market conditions produce a better price than the minimum acceptable specified in the order. Rule 611 of Regulation NMS — the Order Protection Rule — requires trading centres to prevent trade-throughs, ensuring that displayed limit orders at the best available price across exchanges are not bypassed at inferior prices.
FINRA Rule 5310 imposes a best execution obligation requiring broker-dealers to use reasonable diligence to obtain the most favourable price reasonably available for customer orders under prevailing market conditions.
Regulatory Protections for Limit Orders
FINRA Rule 5320, Prohibition Against Trading Ahead of Customer Orders, is the primary regulatory protection for customer limit orders. It prohibits member firms from executing trades for their own proprietary accounts at prices that would satisfy a customer's pending limit order without first filling the customer's order. If a firm holds a customer's buy limit order at fifty dollars and the stock becomes available at fifty dollars, the firm must fill the customer's order before trading for its own account at that price.
The minimum price improvement required for a firm to trade ahead of a customer limit order is one cent for NMS stocks priced at one dollar or more — meaning the firm's proprietary trade must be at forty-nine dollars and ninety-nine cents or below to lawfully bypass the customer's fifty-dollar buy limit without triggering the order. This one-cent minimum price improvement requirement is codified in FINRA Rule 5320 Supplementary Material .06.
FINRA Rule 6460, Display of Customer Limit Orders, requires market makers displaying quotations in OTC equity securities to publish immediately a bid or offer reflecting customer limit orders that would improve their displayed quotation, ensuring that customer limit orders at better prices than the market maker's current quote are visible to the marketplace.
Time Conditions on Limit Orders
Limit orders may be combined with time specifications that govern how long the order remains active if not executed.
A day order expires at the end of the trading day if not executed — it is the default time condition if no other specification is provided. Most limit orders placed by retail investors are day orders unless otherwise specified.
A good-till-cancelled order remains active until it is either executed or the investor explicitly cancels it. GTC orders provide the investor with longer-term price target coverage without requiring daily reentry, but they carry the risk of executing at a time when the investor's circumstances or market view have changed. Investors must monitor GTC orders and cancel them if they no longer wish to transact.
Fill or kill requires immediate execution of the entire order quantity or cancellation — partial fills are rejected. Immediate or cancel allows partial fills and cancels any unfilled portion immediately. These all-or-nothing and partial-execution variants are used primarily by institutional investors managing large positions where partial fills may be operationally inconvenient.
Limit Orders Versus Market Orders — The Core Trade-off
The fundamental choice between limit orders and market orders reflects a trade-off between price certainty and execution certainty.
A market order executes immediately at whatever price the market offers — the investor is certain the order will be filled but has no guarantee of price. In fast-moving or illiquid markets, a market order may execute at a price significantly different from the last quoted price, a phenomenon called slippage. For illiquid securities or large order sizes, market orders carry substantial execution price risk.
A limit order provides price certainty — the investor knows the worst price at which they will transact — but sacrifices execution certainty. In a rapidly rising market, a buy limit order may never be reached. In a rapidly falling market, a sell limit order may never be triggered. The investor may miss the intended transaction entirely.
For most retail investors trading liquid large-cap equities, the practical difference between market and limit orders is small because bid-ask spreads are narrow and market impact is minimal. For illiquid securities, small-cap stocks with wide spreads, or large orders where market impact is a genuine concern, the limit order provides meaningful protection against adverse execution prices.
Limit Orders in the National Market System
Regulation NMS, adopted by the SEC on June 9, 2005 and codified at 17 CFR Part 242, established the current national market system framework within which limit orders operate. Rule 611 of Regulation NMS — the Order Protection Rule — requires every trading centre to maintain policies preventing trade-throughs of protected quotations — displayed quotes at the national best bid and offer — on other trading venues. A displayed buy limit order at the national best bid is therefore protected against being bypassed by trades at inferior prices on other exchanges. Rule 612 of Regulation NMS establishes the minimum pricing increment of one cent for orders and quotations priced at one dollar or more, setting the minimum granularity for limit order price specification.
The Limit Order Display Rule — Rule 604 of Regulation NMS — requires market makers and specialists to display customer limit orders that improve upon their own displayed quotation, ensuring that customer limit orders contribute to public price discovery rather than sitting hidden in broker-dealer order books.
Examination Relevance and Key Takeaways
Limit orders are tested on the SIE and Series 7 examinations in the context of order types, market structure, best execution, and the regulatory protections governing customer order handling.
The key points to retain are these.
A limit order specifies a maximum price for a buy or a minimum price for a sell — it executes only at the limit price or better, never at a worse price. A buy limit order executes at or below the limit price. A sell limit order executes at or above the limit price. Limit orders may receive price improvement — executing at a better price than specified — but never at a worse price. Day orders expire at the close if unfilled. GTC orders remain active until executed or cancelled. FINRA Rule 5320 prohibits member firms from trading ahead of customer limit orders — the firm's proprietary trade must provide at least one cent of price improvement on NMS stocks priced at or above one dollar to bypass a held customer limit order lawfully. FINRA Rule 6460 requires market makers to display customer limit orders that improve upon their quoted prices. Regulation NMS Rule 611 protects displayed limit orders at the national best bid or offer from trade-throughs on other exchanges. The fundamental trade-off between limit and market orders is price certainty versus execution certainty — limit orders guarantee price but not execution, while market orders guarantee execution but not price.
