Chapter 8: Trading Securities

DIGITS & VOL DELETED/RESUMED

Deleted -message that appears when the first digit of the price and the volume will be dropped Resumed -message appears when activity slows

Third Market (OTC Listed)

-(Nasdaq Intermarket) trading market in which exchange listed securities are traded in the OTC market -B/D's registered as OTC market makers in listed securities can effect third-market transactions -*trades must be reported to the Consolidated Tape within 90 seconds of execution

Trade Halting (Circuit Breaker Rule)

-10% market decline: 1 hour halt -20% market decline: 2 hour halt -30% market decline: halt for remainder of day

At-the-Open and Market-on-Close Orders

-ATO orders are executed at the opening of the market -partial execution is allowable -must reach trading post by opening or canceled -MOC orders executed at or as near as possible to to the closing price in the OTC market -in NYSE, must be entered by 3:40 pm and entered at the closing price

Insider Short Sale Regulations

-Act of 1934 prohibits directors, officer, and principal stockholders (insiders) from selling short stock in their own companies

Listed Markets

-Location >NYSE and other exchanges, have central marketplaces and trading floor facilities -Pricing System >operate as a double-auction market >floor participants compete among themselves to execute trades at prices most favorable to the public

OTC Markets

-Location >no central marketplace >over phone, computer networks, trading rooms -Pricing System >works thru a interdealer network >negotiated market

Trading Hours

-NYSE trades between 9:30 am and 4:00 pm -retail OTC is the same as NYSE (extended hours until 6:30 pm) -after hours market is much less liquid because order flow is limited -spreads between bid and ask prices are wider and there is greater price volatility

Counter offer/bid

-OTC trader may attempt to negotiate a better price with a market maker -*to guarantee execution, buy at ask price or sell at bid price

Markup Policy Considerations

-Type of security: more risk for making markets and trading common stock than bonds -Inactively traded stocks: greater risk for thin markets that are volatile -Selling price of security: commission and markup rates should decrease as a stock's price increases -Dollar amount of a transaction: transactions of relatively small dollar amounts generally warrant higher percentage markups than large-dollar transactions -Nature of B/D's business: pertains to full-service brokers vs. discount brokers. General securities broker has higher operating costs than discount broker -Pattern of markups: look for past unfair markups -Markups on inactive stocks (Contemporaneous Stocks): for inactive stocks and situations where no market quotes are available, may base markup on its cost of the stock

Filing an Order

-a firm may act as the client's agent by finding a seller of the securities and arranging a trade -a firm may buy the securities from a market maker, mark up the price, and resell them to the client -if it has the securities in its own inventory, the firm may sell the shares to the client from that inventory

OTC Market

-a highly sophisticated telecommunications and computer network connecting B/D's across the country Includes: >American depository receipts (ADRs) >common stocks, especially of banks and insurance and technology companies >most corporate bonds (typically convertibles) >municipal bonds >US government securities >preferred stock >equipment trust certificates >closed-end investment companies >warrants *(p. 378)

Do Not Ship DNS

-a limit order to buy or sell that is to be quoted and/or executed in whole or in part by the NYSE only

Fourth Market

-a market for institutional investors in which large blocks of stock, both listed and unlisted, trade in transactions unassisted by B/D's -transactions take place thru Electronic Communications Networks (ECN) (open 24 hours a day and act solely as agents)

Dealer

-acts as a principal, dealing in securities for its own account and at its own risk -charges a markup or a markdown -may make markets and take positions (long/short) in securities -must disclose its role to the client and the markup or markdown if a Nasdaq Security

Broker

-acts as an agent; transacting orders on the client's behalf -charges a commission -is not a market maker -must disclose its role to the client and the amount of its commission

5% Markup Policy

-adopted to ensure that the investing public receives fair treatment and pays reasonable rates for brokerage services in both exchange and OTC markets -considered a guideline ONLY and NOT a firm rule for markup and markdowns Order can be filled: >if the B/D is a market maker in the security, it will (as principal) buy from or sell to the customer, charging a markup or markdown >if the firm is not a market maker in the security, it can fill the order as agent, without taking a position in the security, and charge a commission for its execution services >an order can be filled as a riskless and simultaneous transaction -*applies to markup/downs and commissions -*does NOT apply to mutual funds, variable annuity contracts, or securities sold in public offerings, municipals or anything with a prospectus -*the price to the customer must be reasonably related to the current market -*the more risk, the higher markup is justified

Reducing Orders

-all orders entered below the market are reduced on the ex-dividend date by the amount of the distribution

Workout Quote

-an approximate figure used to provide the buyer or seller with an indication of price, not a firm quote -block positioners use workout quotes frequently

Over-The-Counter (OTC) Market (Second Market)

-an inter-dealer market in which unlisted securities trade -securities dealers are connected by computer and phone -trade stocks, bonds, all municipals and US Government securities -Nasdaq >Global Select Market >Global Market >Capital Market -Non-Nasdaq >Pink Sheets >OTC Bulletin Board

Day Orders

-an open order (stop or limit) is assumed to be a day order, valid only until the close of trading on the day it is entered

Riskless and Simultaneous Transaction

-an order to buy or sell stock in which the firm receiving the order is not a market maker Two options to fill order: >as agent for the customer, it could buy or sell on the customer's behalf and charge a commission, subject to the 5% policy >buy or sell for its riskless principal account, then buy or sell to the customer as principal, charging a markup/down subject to the 5% policy

OPD

-announces the initial transaction in a security for which the opening has been delayed

Listed Security

-any security listed for trading on an exchange

Nasdaq Level 2

-available to approved subscribers only -provides the current quote and quote size available from each market maker in a security in the system

Stop Order

-becomes a market order of the stock reaches or goes through the stop (trigger or election) price -**protects a profit or prevents a loss -buy orders entered above the market; sell orders entered below the market Exchange >Acceptable on all exchanges as day or GTC orders OTC Orders >acceptable by some dealers

Securities and Exchange Commission (SEC)

-composed of five commissioners appointed by the President and approved by the Senate -enforces the 1934 Act by regulating the securities markets and the behavior of market participants

Exchange Market (Auction Market)

-composed of the NYSE and other exchanges on which listed securities are traded

Nasdaq Level 1

-displays the inside market only, the highest bids and the lowest asks for securities included in the system -available to registered representatives thru various public vendors

Stop Limit Order

-entered as a stop order and changed to a limit order if stock hits or goes through the stop (trigger or election) price -stop order that becomes a limit order once the stop price has been reached or exceeded Exchange >acceptable on all exchanges as day or GTC orders OTC Orders >acceptable by some dealers

Floor Brokers (Commission House Brokers)

-execute orders for clients and for their firm's accounts

Market Order

-executed immediately at the market price -buy or sell at the best available market price Exchange >most common order type on all exchanges OTC Orders >most common OTC order type

Specialist/Designated Market Maker (DMM)

-facilitate trading in specific stocks, and their chief function is to maintain a fair and orderly market in those stocks -act as both brokers and dealers; dealers when they execute trades for their own accounts and brokers when execute orders other members leave with them -acts as an auctioneer -receive rebates on fees charged by the exchange whenever their quotes result in trades -minimize price disparities

NYSE Delisting

-failure to meet minimum maintenance criteria -bankruptcy -low share price or share volume -corporate actions not deemed to be in the public interest

Immediate-or-Cancel Orders (IOC)

-fill entire order immediately at the limit price or better -*Partial fill is acceptable

Fill-or-Kill Orders (FOK)

-fill entire order immediately at the limit price or better -NO partial fill

Broker/Dealers

-firms engaged in buying and selling securities for the public

Stock Ahead

-if a limit order at a specific price was not filled, chances are another order at the same price took precedence; that is, there was a stock ahead

Quotes

-in terms of bid and ask -Ask: price at which dealers are willing to sell -Bid: price at which dealers are willing to buy -Spread: difference between the bid and ask

REPEAT PRICES OMITTED

-indicates that the Tape will show only transactions that differ in price from the previous reports

SLD

-indicates that the exchange did not report a sale on time, so it is out of sequence on the Tape -trade is late

Qualifiers

-intended to allow the B/D to back away if market conditions change -usually reserved for situations in which a market maker knows that special handling will be required to accomodate a particular trade -either the order size is too big for the market to absorb without disruption or the market is too thin or temporarily unstable

Do Not Reduce (DNR)

-is not reduced by an ordinary cash dividend

Spread (Influencers)

-issue's size -issuer's financial condition -amount of market activity in the issue -market conditions

Regional Exchanges

-less stringent -list smallest and newest companies -Boston Stock Exchange, Chicago Stock Exchange, Philadelphia Stock Exchange

Limit Order

-limits the amount paid or received for securities -minimum price for sell orders; maximum price for buy orders Exchange >handled by a specialist (DMM) as a day or good-till-canceled order OTC Order >acceptable on either a day or GTC basis

90-second Reporting

-market maker transactions must be reported within 90 seconds after a trade's execution

HALT

-means that trading in a security has been halted

Registered Trader

-members of the Exchange who trade primarily for their own accounts -if they accept a public customer's order from a floor broker, they must give that order priority -may not execute their own trades while holding an unfilled public order

All-or-None Orders (AON)

-must be executed in their entirety or not at all -can be day or GTC orders -do NOT have to be filled immediately

Sell Order Tickets

-must be identified as either long or short Long >has title to it >purchased the security or has unconditional contract to purchase but has not received >owns a convertible or exchangeable security and has tendered for conversion or exchange >has an option to purchase the security and has exercised

Alternative Orders (OCO)

-one cancels the other -if one of the orders is executed, the other is immediately canceled

Subject Quote

-one in which the price is tentative, subject to reconfirmation by the market maker -are hedged

Super Display Book (SDBK)

-orders sent to the trading post sent electronically -process nearly 75% of NYSE orders -any order that cannot be matched is left for the DMM to handle

Nasdaq Level 3

-provides both levels 1 and 2 -allows registered market makers to input and update their quotes on any securities in which they make a market

Three-Quote Rule

-quoted on either Pink Sheets or OTCBB -unless there are at least two market makers displaying firm quotes, B/D's receiving orders to buy or sell non-Nasdaq securities must contact a minimum of three dealers to determine the prevailing price

Consolidated Tape System (CTS)

-receives, validates, and sequences the last sale price and size of all equity transactions in listed securities from all US Stock Exchanges and FINRA -*made available via computer-to-computer linkages and ticker networks to subscribers within the financial community Network A >reports transactions in NYSE-listed securities wherever they are traded Network B >last sales for securities that are listed in the NYSE AMEX, Regional Exchanges, Local Issues, and Bonds -*report market identifiers, its price and the number of shares -*do NOT include commissions, mark-ups/downs

Volume Reports

-reg market makers must make daily reports to Nasdaq of their total daily volume in all securities for which they are registered market makers

Market Maker Reports

-reg market makers must transmit reports of last sales made during desginated transaction-reporting hours -must include a security's Nasdaq symbol, the number of shares, the transaction price, and whether the trade was buy, sell, or cross

Regulation SHO

-rescinded the up-tick rule for exchange-listed stock and the bid test rule for Nasdaq Global Select and Global Market -*mandates a locate requirement; before the short sale of any equity security, firms must locate the securities for borrowing to ensure that delivery will be made on settlement date -aka naked short selling is not permitted

Nominal Quote

-someone's assessment of where a stock might trade in an active market -used to give customers an idea of the market value of an inactively traded security, but NOT firm quotes -must be labeled Nominal

Arbitrage

-specialized traders use to profit from temporary price differences between markets or securities Market Arbitrage >buy lower price in one market and sell higher in the other market Convertible Security Arbitrage >may be able to convert bonds to stock and sell the stock for profit Risk Arbitrage >become possible in proposed corporate takeovers >buy stock in company being acquired and sell short in acquiring company's stock

Manipulative and Deceptive Practices

-the Conduct Rules mandate that any quote given must represent a real bid or offer -no fictitious quotes are allowed

OTC Market Makers

-the OTC market has NO specialists -firms looking to make a market, must register with FINRA -buy and sell for their own inventories, for their own profit, and at their own risk -B/D acting as a market maker, acts as a principal, NOT an agent

Inside Market

-the best bid (highest) price at which stock can be sold in the interdealer market and the best ask (lowest) price at which the same stock can be bought

National Association of Securities Dealers Automated Quotation (Nasdaq)

-the computerized information system that tracks OTC equities trading

The Securities Act of 1934 (Exchange Act)

-the creation of the SEC -the regulation of exchanges -the regulation of the OTC market -the regulation of credit by the Federal Reserve Board -the registration of B/D's -the net capital rules -the regulation of insider transactions, short sales, and proxies -the regulation of trading activities -the regulation of client accounts -the customer protection rule -the filing of 10-Qs, 10-Ks, and other financial statements by companies that are required to report -the regulation of officers, directors, and principal shareholders

Not Held Orders (NH)

-the customer agrees not to hold the floor broker or B/D to a particular time and price of execution -Floor broker has authority over time and price -*Market Not Held Orders = Day Orders

Secondary Market

-the market in which securities are bought and sold

Firm Quotation

-the price at which a market maker stands ready to buy or sell at least one trading unit-100 shares of stock or five bonds-at the quoted price with other member firms -*all quotes are firm quotes unless otherwise specified -when a market is made, B/D must be willing to buy or sell at least one trading unit of the security at its firm quote

Crossing Orders

-two market orders for the same stock, member may cross the two orders and use one order to fill the other -must offer the stock at least $.01 higher than the bid

Recognized Quotation

-under FINRA rules, is any public bid or offer for one or more round lost or other normal trading units -if not a round lot, must state the amount of the security

Size

-unless otherwise specified, a firm quote is always good for one round lot (100 shares)

Two-Dollar Broker

-use when commission brokers are too busy -charge commissions for their services

Good-Till-Canceled Orders (GTC)

-valid until executed or canceled -automatically canceled on last business day of April and October

Backing Away

-violation -a market maker that refuses to do business at the price(s)

Proceeds Transaction

-when customer uses proceeds of a sale to purchase other securities, the combined commissions and markups must be consistent with 5% markup policy

Auction Market (Double Auction Market)

-where exchange securities are bought and sold -both buyers and sellers call out their best bids and offers in an attempt to transact business at the best price possible

Awarding Trades

1. Priority- first order in 2. Precedence- largest order of those submitted 3. Parity- random drawing