RaoulFoucault

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Electronic communications networks (ECNs) Many traders look for ways to get around dealing with a traditional broker. Instead they access trades using a direct-access to the broker's servers. We talk more about the differences in Chapter 3. A new system of electronic trading that is developing is called the electronic communications network (ECN). ECNs enable buyers and sellers to meet electronically to execute trades. The trades are entered into the ECN systems by market makers at one of the exchanges or by an OTC market maker. Transactions are completed without a broker-dealer, saving users the cost of commissions normally charged for more traditional forms of trading. Subscribers to ECNs include retail investors, institutional investors, market makers, and broker-dealers. ECNs are accessed through a custom terminal or by direct Internet dial-up. Orders are posted by the ECN for subscribers to view. The ECN then matches orders for execution. In most cases, buyers and sellers maintain their anonymity and do not list identifiable information in their buy or sell orders. In the last few years ECNs have gone through consolidation, and there are only two independent ECNs left. The two independent ECNs, Instinet and Bloomberg Tradebook, primarily service the institutional marketplace. If you want to trade through Instinet, you can do so as part of its partnership with E*Trade. Archipelago now operates under the HYSE umbrella as HYSE Arca Options. Understanding Order Types Buying a share of stock can be as easy as calling a broker and saying that you want to buy such and such a stock — but you can place an order in a number of other ways that give you better protections. Most orders are placed as day orders, but you can choose to place them as good ’til canceled orders. The four basic types of orders you can place are market orders, limit orders, stop orders, and stop-limit orders. Understanding the language and using it to protect your assets and the way you trade are critical to your success as a trader. The next few sections explain the nuances of placing orders so you don’t make a potentially costly mistake by placing a market order when you intended to place a limit order. Putting a stop-limit order in place may sound like the safest way to go; however, doing so may not help you in a rapidly changing market. Market order When you place a market order, you’re essentially telling a broker to buy or sell a stock at the current market price. A market order is the way your broker normally places an order unless you give him or her different instructions. The advantage of a market order is that you’re almost always guaranteed that your order is executed as long as willing buyers and sellers are in the marketplace. Generally speaking, buy orders are filled at the ask price and sell orders are filled at the bid price. If, however, you’re working with a broker who has a smart-order routing system, which looks for the best bid/ask prices, you sometimes can get a better price on the NASDAQ or Amex exchanges. Whenever the order involves the NYSE, you need a good floor broker. In most brokerage houses, market orders are the cheapest to place with the lowest commission level. The disadvantage of a market order is that you’re stuck paying the price when the order is executed — possibly not at the price you expected when you placed the order. Brokers and real-time quote services quote you prices, but because the markets move fast, with deals taking place in seconds, you’ll probably find that the price you’re quoted rarely is the same as the execution price. Whenever you place a market order, especially if you’re seeking a large number of shares, the probability is even greater that you’ll receive different prices for parts of the order — 100 shares at $25 and 100 shares at $25.05, for example. Limit order If you want to avoid buying or selling stock at a price higher or lower than you intend, you must place a limit order instead of a market order. When placing a limit order, you specify the price at which you’ll buy or sell. You can place either a buy limit order or a sell limit order. Buy limit orders can be executed only when a seller is willing to sell the stock you’re buying at the limit price or lower. A sell limit order can be executed only when a buyer is willing to pay your limit price or higher. In other words, you set the parameters for the price that you’ll accept. You can’t do that with a market order. The risk that you take when placing a limit order is that the order may never be filled. For example, a hot stock piques your interest when it is selling for $10, so you decide to place a limit order to buy the stock at $10.50. By the time you call your broker or input the order into your trading system, the price already has moved above $10.50 and never drops back to that level, thus your order won’t be filled. On the good side, if the stock is so hot that its price skyrockets to $75, you also won’t be stuck as the owner of the stock after purchasing near the $75 high. That high will likely be a temporary top that quickly drops back to reality, forcing you to sell the stock at a significant loss at some point in the future. Most firms charge more for executing a limit order than they do for a market order. Be sure that you understand the fee and commission structures if you intend to use limit orders. Stop order You may also consider placing your order as a stop order, which means that whenever the stock reaches a price that you specify, it automatically becomes a market order. Investors who buy using a stop order usually do so to limit potential losses or protect a profit. Buy stop orders are always entered at a stop price that is above the current market price. When placing a sell stop order, you do so to avoid further losses or to protect a profit that exists in case the stock continues on a downward trend. The stop price is always placed below the current market price. For example, when you have a stock that you bought for $10 that now is selling for $25, you can decide to protect most of that profit by placing a sell stop order that specifies that stock be sold when the market price falls to $20, thus cementing a $10 gain. You don’t have to watch the stock market every second; instead, when the market price drops to $20, your stop order automatically switches to a market order and is executed. The big disadvantage of a stop order is that if for some reason the stock market gets a shock during the news day that affects all stocks, it can temporarily send prices lower, activating your stop price. If it turns out that the downturn is actually merely a short-term fluctuation and not an indication that the stock you hold is a bad choice or that you risk losing your profit, your stock may sell before you ever have time to react. The bottom can fall out of your stock’s pricing. After your stop price is reached, a stop order automatically becomes a market order and the price that you actually receive can differ greatly from your stop price, especially in a rapidly fluctuating market. You can avoid this problem by placing a stop-limit order, which we discuss in the next section. The bottom can fall out of your stock’s pricing. After your stop price is reached, a stop order automatically becomes a market order and the price that you actually receive can differ greatly from your stop price, especially in a rapidly fluctuating market. You can avoid this problem by placing a stop-limit order, which we discuss in the next section. ✓ Check with the brokers you’re planning to use to ensure that they accept stop orders. ✓ Find out what your brokers charge for stop orders. ✓ Review how your brokers’ stop orders work, so you don’t run into surprises. After all, you don’t want to execute a stop order and end up selling a stock that you didn’t intend to sell or at a price you find unacceptable. Stop-limit order You can protect yourself from any buying or selling surprises by placing a stop-limit order. This type of order combines the features of both a stop order and a limit order. When your stop price is reached, the stop order becomes a limit order rather than a market order. A stop-limit order gives you the most control over the price at which you will trade your stock. You can avoid a purchase or sale of your stock at a price that differs significantly from what you intend. But you do risk the possibility that the stop-limit order may never be executed, which can happen in fastmoving markets where prices fluctuate wildly. For example, you may find that deploying stop-limit orders is particularly dangerous to your portfolio, especially when bad news breaks about a stock you’re holding and its price drops rapidly. Although you have a stop-limit order in place, and the stop price is met, the movement in the market may happen so rapidly that the price limit you set can be missed. In this case, the limit side of the order actually prevents the sale of the stock and you risk riding it all the way down until you change your order. For example, say you purchased a stock at $8 near its peak. On the day the company’s CEO and CFO were fired, the stock dropped to $4.05. You may have had a stop-limit order in place to sell at $5, but on the day of the firing, the price dropped so rapidly after the company announced the firing that your stop-limit order could not be filled at your limit price. Stop-limit orders, like stop orders, are more commonly used when trading on an exchange than in an OTC market. Broker-dealers likewise can limit the securities on which stop-limit orders can be placed. If you want to use stoplimit orders, be sure to review the rules with your broker before trying to execute them.

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At the OP, have you already tried them?

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