Limit Order Book

What Is a Limit Order Book?

A limit order book is a record of outstanding limit orders maintained by the security specialist who works at the exchange. A limit order is a type of order to buy or sell a security at a specific price or better. A buy limit order is an order to buy at a preset price or lower while a sell limit order is an order to sell a security at a pre-specified price or higher.

When a limit order for a security is entered, it is kept on record by the security specialist. As buy and sell limit orders for the security are given, the specialist keeps a record of all of these orders in the order book. The specialist executes the orders at or better than the given limit price when the market moves to the pre-specified price.

Understanding a Limit Order Book

The specialist running the limit order book has the responsibility to guarantee that the top priority order is executed before other orders in the book, and before other orders at an equal or worse price held or submitted by other traders on the floor, such as floor brokers and market makers.

The specialist earns a profit off of the spread between the difference in prices between the bid and ask orders on their book as they execute the orders. With the advancements in trading system technologies, the process has shifted from a manual process to one that is largely automated.

Tracking Limit Orders

In 2000, the Securities and Exchange Commission (SEC) began to create a centralized limit order book that keeps track of limit orders on exchanges electronically. This electronic order tracking system automatically matches for the execution of the best possible pair of orders in the system. The best pair is made up of the highest bid, and the lowest ask orders. The bid is the price the specialist or exchange will sell a security or the price at which an investor can buy the security. The ask or offer is the price at which the specialist or exchange will buy a security or the price at which the investor can sell the security.

When a limit order is entered into a trading system and fielded by either a specialist working the book or an electronic database of orders, it will stay on the books until it can be matched with a suitable trade and executed. Buy limit orders are placed with an upper price threshold. The investor would say "I don't want to pay more than $X for this share." Sell limit orders are placed with a lower price threshold. The investor would say "I don't want to sell this share for less than $X."

Special Considerations

Investors are guaranteed to get the price if the order is triggered after the market moves to the specified level. However, there is no guarantee that the limit order will be executed. In other words, the order can only be filled if the price hits the price level. Limit orders are helpful to investors because they help ensure that they don't pay more for a security than the pre-set price initially established with the order.