Trading Markets

Characteristics of Order Tickets

(1) Buy or Sell (2) Sell Long or Sell Short (3) Short Sale Fundamentals (4) Order Size (5) Day order/Good Until Cancelled *Trading Markets Outlines* (6) AON "All or None"- either the entire order is filled or none of it is (7) FOK "Fill or Kill"- either the entire or is filled or it is killed (8) IOC "Immediate or Cancel"- either part of the order is filled on the first try and the balance is canceled. There can no extra attempts at executing the order.

(Rule 611) Trade Through Rule

(An execution of an order in that market at an inferior price to that displayed in another market). Eliminates "trade-throughs"

Specialists/DMMs and Public

*DMMs are prohibited from dealing with the public because they are wholesalers of securities and only deal members of the NYSE* (1) Retail firms deal with customer order and go to the exchange floor to execute the trade with the specialists/DMM. For acting as a middle man, the retail firms receive a commission. (2) DMM are owned by major banks as separate operating entities. Banks pay for Specialists to be on the exchange

Institutions and OTC

*Fourth market is direct trading of securities between institutions, without the use of a broker* *Market was developed in the 1960's because at that time the NYSE had fixed commissions rates. Under these rates, institutions didn't get large discounts for large trades, so the cost of trading for theses firms was high* Instinet (Institutional Network) was created at that time as a way for firms to bypass commission rates-*posted listing of offering of securities to sell, or bids for securities they wished to buy* In 1975, fixed commission were abolished and so was Instinet.

Regulation Alternative Trading Systems (ATS)

*Written by the SEC* Requires that ATS (ECNs) to register with the SEC and be regulated as broker-dealers, meaning that they are not Self-Regulating Organization (SROs), meaning that they cannot discipline their members for rule violations. ATSs- have no rules for their users other than the types of order that can bt placed and they cannot discipline their users, other than restricting access to their systems.

Buy Limit Order

A limit order to buy has been placed (the price is the limit). The order was placed GTC (good to cancelled), because it would be cancelled by the end of the day if it was a "day order" *placed below current market*

Sell Limit Order

A limit that states that securities can only be sold if stock reaches a certain price. *made above the current market and will be exercised only if the market rises*

Consolidation Quotations Service

Promotes competition among trading market of NYSE and NYSE-MKT issues. *Is a centralized electronic quoting service devised by the SEC to that allows investors to quote stocks from both exchanges without having to physically walk into them. *Allows for comparison shopping*

UQDY-UTP Quote Data Feed

Promotes current price quotes(not actual trade reports) for NASDAQ listed securities, regardless of the source of the quote. Thus, these quotes might come from the NASDAQ market maker, a market maker from the NYSE, a regional market maker that trades stock via an Unlisted Trading Privilege Plan,or an ECN.

Second Market

Where OTC trading of stocks not listed on the NYSE, NYSE_MKT, or NASDAQ occur.

In OTC Transactions, Firm Can Be Brokers/Dealers

In each OTC transaction, a firm can either act as a broker or dealer, but they cannot act as both *Brokers-earn a commission (agency transactions; real estate brokers)* *Dealers-earn a mark-up (principal transaction; car salesman)*

Thin Trading

In the second market, there is very little trading due to the small number of market makers per stock (usually 2 or 3)

NASDAQ and OTC Market Makers

In the secondary market, OTC firms are called broker/dealers b/c they can handle both the NASDAQ market or OTC market stocks. *Brokers/dealers act as middlemen between retail customers and market makers* *When stock is sold from a dealer to a retail customer, the stock is marked up*

Electronic Communications Network (ECNs)

Instinet is the first of what are now called ECN's-Electronic Communications Networks, that match customer buy and sell orders 24 hours a day on an agency basis.

Pink OTC Markets

Investors buy and sell stocks on "pink sheets" Began in 1931.

Limit Order Specifies A Price

Limit Order specify a price at which to buy or sell. To understand how these orders (and stop orders) are used, focus on the securities price at the time the order is placed.

Specialists

Limit order to buy and sell are given to specialists on the stock exchange *(they act as a brokers broker)* The specialist is at the center of trading and executes these orders for the retail firms. In this case, the specialist is acting as a broker for another brokerage firm. *For performing this function, the retail firm shares its commission with the designated market makers (dmms)*

(Rule 606) Reports to Customers on order routing and payment for order flow

Most market maker have a policy for "paying for order flow" that is they pay a small amount to the firm that direct the order to that market maker. in essence, the market maker is rebating some of its profit. *In the real world, whoever is the dominant player in the market sets the price and moves it according to market conditions; and the other smaller market maker continuously match that price* Requirements are: (1) the firm that received the payment for order flow must be disclosed on the customer trade confirmation (2) the firm on the request of the customer must disclose the identity of the market to which the customers' order were routed for execution in the preceding 6 months along with the time of execution. (3) quarterly detailing report that is publicly available that details the identity of the 10 largest markets or market makers to whom non-directed order were routed and any other venue that received 5% or more of the forms order, member firms relationships, arrangement if any for order flow or profit sharing (making everything be out in the open)

Three "New" Rules that Impact Market Participants (610-612)

(1) (Rule 611) All market centers are required to enforce "trade throughs" (an execution of an order in that market at an inferior price to that displayed in another market) (2) (Rule 610) Market centers must provide a "level playing field" when giving access to their markets (ex. access fees must be consistent across all market participants). Each market must provide for automated access and execution that does not favor one group over another. (3) (Rule 612) Sub-penny pricing is prohibited unless the stock is trading below 1 dollar. All limit order and displayed quotes for NMS securities must be in penny increments.

*Corporate, Government, Municipal Debt, Government Debt, Agency Issues, Variable Annuities, and the OTC Market*

All corporate bond trades and all corporate commercial paper trades take place OTC. Government bonds and Municipal bonds trade OTC but are not regulated by FINRA.

NASDAQ

Both the NYSE and NASDAQ responded to the growth of ECNs in a similar fashion by purchasing (Instinet and Island already had 50% of the NASDAQ trading volume because of superior technology and cheaper trading price); and the NYSE purchased Archipelago to keep up with the trend of technological trades opposed to those that occur on the floor.

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Brokers and Dealers

Dealers Quotes In Bid and Ask

Dealers are in terms of Bid and Ask. *(1)The Ask price is the price the which the dealer will seller the security (the ask price is always higher than the bid price-difference is the spread)* *(2) The Bid Price is the price the dealer is willing to buy stock* *(3) Inside quote is the highest bid/lowest ask in the nation*

OTC trading of Exchange Listed Securities

Developed in the 1960's, but really did not come into prominence until the 1980's. At that time, the NYSE has a rule that if a member firm had an order to buy or sell an exchange listed stock during the hours the exchange was open, the trade had to be performed on the exchange floor. *NYSE, NYSE-MKT, and NASDAQ dislike the third market because it will offer better price than their exchanges to grab an order that if the third market wasn't, there they would get* *Third market stays open 24 hours a day and grabs orders from institutions that wish to trade when the exchanges are closed, and will pay for orders sent to them from firms* *Because of 3rd markets, major markets are taking steps closer to staying open later (promotes competition, good for investors)*

After Hours Market

ECN's stay open 24 hours a day and a large number of their trades when the NMSs are closed. *After hours market is less liquid, order flow is limited and getting execution is much more difficult and can be more costly, greater volatility due to after hours trading because there is fewer trades.*

(Rule 604) Limit Order Display Rule

Exchanges and market makers must display customer limit orders publicly, so that they can be accessed by all investors. Requires that a market maker received a customer limit order that was better priced that its own quote had to display that customer order instead of its own quote (showed the best prices in the market).

Market Order

Filled out immediately at the market price. There is no price specified on the order. A market order-Not Held is to be filled at whatever time and price the trader thinks best *(must be completed that day, do not carry over to the next day)*

Secondary Market Division *Test Question*

First Market Second Market Third Market Fourth Market

Dealer Quotes In Bid and Ask

For the market to function, the market must be liquid. *Dealers are expected to maintain an inventory of each security in which they make a market: to buy if a customer wishes to sell, and to sell if a customer wishes to buy*

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Fourth Market ECNs/ATSs

Unlisted Trading Privileges (UTP)

Promotes Competition with the NASDAQ. NA*SDAQ gets competition from exchanges that trade NASDAQ issues under a so-called UTP plan*

Network A and B Tape Trades

Network A Tape: Reports trades of NYSE listed issues, regardless of the market center where the trade takes place *Test Question- Seller Must Report Sale in 1.5 Minutes (90 secs); fined must be paid by firm if not* Network B Tape: Reports trades of NYSE-MKT listed issue, regardless regardless of the market center where the trade takes place. Also reports trades of stocks listed on other regional exchanges, such as the PHLX.

Primary Market

New Issues are being sold to the public for the first time

Specialists/DMMs Are Dealers On The NYSE

On exchange floors, the dealers are called specialists, also called DMM (designated market makers). *There are 5 specialist firms handling the approximately 3,000 NYSE listed issues, so each DMM firm handles 600 different stocks* (1) *the specialist/dmm is the sole market maker in that stock

No Options OTC

Options don't trade over the counter. The OCC only guarantees options contracts on exchanges.

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Order Ticket Information

OTCBB

Over the Counter Bulletin Board. *It is not an exchange because it cannot execute trades* *Ran by FINRA* *Displays quotes for publicly traded companies that are not listed on an exchange (companies either do not meet standards or have been delisted)*

Quotes for NYSE and AMEX

Provides current price quotes for exchange listed securities, regardless of the source of the quote. Once a trade occurs, it is reported to the *Consolidated Tape*

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Regulation Rules

ECN Must Link If It Trades

Regulation requires that any ATS: (1) that displays order to anyone other that ATS employees (2) has a trading volume in an *NMS (National Market Securities: NYSE, NYSE-MKT, and NASDAQ)*of 5% aggregate volume in the issue for 4 of the last 6 months must (3) link with a national securities exchange so that ECN's quote is displayed and can be accessed under regulation NMS

(Rule 602) Exchanges must collect and display bids/offers

Requires each exchange to establish a mechanism for collecting bids, offers, and quotation size from broker-dealers and for disseminating this data to "quotations vendors". Also obligates broker dealers to promptly communicate changes in bids and offer.

(Rule 605) Market Center Order Execution Report

Requires market center to make available to the public monthly reports that summarize their order execution. Includes: *Spreads, How market orders were executed relative to public quote, speed of execution, fill rates, and price movements* *Excludes Pink Sheets*

(Rule 610) Market Access

Requires quoting market centers and quoting market participants to offer automatic execution of order, and they cannot discriminate by offering members faster automatic execution than that offered to non-members. Also, rule eliminates "locked" and "crossed" markets across all market venues; and must have rules that prohibit members from engaging in patterns of locking and crossing.

(Rule 607) Customer Notice of Payment For Order Flows

Requires that broker-dealers notify each new customer at account opening, and annually thereafter of: (1) policy regarding receipt of payment for order flow (2) broker-dealers' policies for determining the routing of each customer order that is subject of payment for order flow.

PaymentsFor Order Flow Is Disclosed

SEC permits this practice because it believes that such competition will result in lower execution costs for the customer. SEC requires that any payments for order flow made be disclosed on customer's trade confirmation.

Payments For Order Flow

SEC requires that member firms route their order to markets posting the best price. So, if the 3rd market is offering an NYSE listed stock for a cheaper price, the order must be sent to the 3rd. *If offerings are the same, some market makers will pay for member firms to buy from them (rebating)*

Over-The-Counter Trading of Unlisted Stocks

Second market developed in the 1900s with the invention of the telephone. Investors could trade over the phone instead of meeting and trade on exchange floors. The OTC market for equity securities consists of the OTCBB and the Pink OTC Market *Stocks on OTC are mainly penny stocks, delisted companies, legit foreign companies that don't want to deal with exchange listed req*

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Secondary Market-Over the Counter (OTC)

(Rule 612) Sub-Penny Quoting

Sub-penny pricing is disallowed? No sub-penny pricing for NMS stocks trading at one dollar or more. (1)*SEC requires that all customer limit order for NMS stocks be in increments of .01. Any limit order that are increments of .001 must be rejected* (2)*Again, does not apply to pink sheets*

Second Market Negotiations

The OTCBB and Pink OTC Markets are "display facilities" only. Their systems display market maker quotes for these unlisted stocks, but to trade, *one must negotiate with the market maker posting the quote. This is the case because there is no rule saying that these quotes be posted in "real time"* To negotiate an OTC stock trade, either the telephone is used; or an interest based trade negotiation application is used.

Primary Market OTC

The entire primary market is an OTC market. New equity issues are initially sold to the first investors OTC. Then the securities are either listed on an exchange or trade OTC.

First Market

The first market is trading of exchange listed securities on the floor of the stock exchange. This was the oldest and largest market. Consists of the NYSE and American Stock Exchange (NYSE-MKT) purchased by the NYSE. *Companies must have a national investor base to be listed on NYSE in the first market. Active Trading Market- 3 billion shares traded annually.

Active Markets and Spreads

The more active the market, the narrower the spread becomes. This makes the market more "efficient" and is better for customers since the spread gives the customer a built in loss

Buy Stop Order

The stop on the order tells the trader that this order cannot be executed until the market reaches the specified price. Once a trade at 75 or higher occurs, this order is triggered and turns into a market order. The order is then filled on the next trade (which can be higher or lower)

Third Market

The trading of exchange listed securities off the floor through over the counter market makers. Third Market trade NYSE listed issues at narrower bid-ask spreads than the market makers on the NYSE, attracting order away from the exchange floor. *Market is open 24 hours a day $$$*

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Third Market-OTC Trading of Exchange Listed Issues

Sell Stop Order

This type of order tell the trader that this order cannot be executed until the market reaches a certain price. Once a trade occurs at the price or lower, this order is triggered and turn into a market order. The order is then filled on the next trade. *Sell stop orders are used to limit losses on long stock positions in falling markets. Thus, they always placed below the current market and are executed if the market falls*

How Orders Work

To place an order in a secondary market, a registered representative fills out an *"order ticket'*- either on paper or electronically. Information on the order to is electronically routed to market posting the best price.

Secondary Market

Trading of issued securities

Options Trading

Trading of options occurs on exchange floor *The largest options exchange is the Chicago Boards of Exchange* In order of greatest to least: Chicago Board Options Exchange Philadelphia Stock Exchange American Stock Exchange Pacific Stock Exchange (International Securities Exchange 20% Market Share)

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Types of Orders

NYSE Bond Trading

Typically traded over the counter, so the NYSE does very limited trading of corporate bonds for those companies that are listed.

NASDAQ Stock Market

Was recognized by the SEC as an exchange in 2006. Instead of having a trading floor, the NASDAQ consists of a computer trading network. *Has minimum listing standards for* *3,000,000 issues and 2 million shares are traded a day* *NASDAQ is not apart of the CQS, because it was too small when the CQS originated. Instead, it shows its own quotes real time called the Network C Tape*

Dual Listing

When companies stock is traded on regional markets and dominant securities markets such as the NYSE. NASDAQ, and NYSE-MKT. Generally, dual listing do not occur between the three largest markets. However, the SEC viewed this as anti-competitive and the rules have been changed as markets have begun to trade others' listings. As a result, trading of stock may not take place on the floor of an exchange but over the counter of on regional exchanges.