Types
of Orders
Customers
who want to buy or sell securities can enter several types of
orders:
- Market
orders - executed immediately at the market price;
- Limit
orders - set a limit on the amount paid or received for the
securities;
- Stop
orders - become market orders if the stock reaches the stop
price (or the trigger price if the order is a stop limit order);
- Stop
limit orders - entered as stop orders and changed to limit orders
if the stock hits the trigger price;
- Day
orders - expire if not filled by the end of the day;
- Good-till-cancelled
orders - do not expire until filled or cancelled;
- At-the-opening
and market-on-close orders - executed at the opening of trading
the day after the order is placed or as close as possible to
the close of trading on the day the order is placed;
- Reducing
orders - automatically drop in price under certain conditions;
- Fill
or kill orders - must be executed immediately in full or in
part; any part of the order that remains unfilled will be canceled;
- All
or none orders - must be executed in full, but not immediately;
Market
(Unrestricted) Orders
An order that is sent immediately
to the floor for execution without restrictions or limits is known
as a market order. It is executed immediately at the current
market price, and it has priority over all other types of orders.
A market order to buy is executed at the lowest offering price
available; a market order to sell is executed at the highest bid
price available. As long as the security is trading, a market
order guarantees execution. No other type of order offers
that guarantee.
Limit
Orders
An order on which a customer has
placed a limit on the acceptable purchase or selling price is
called a limit order. Limit orders are usually not executed
immediately (unless the price is right). A sell order at
a limit sets a minimum price at which the customer is willing
to sell the stock. The customer will gladly accept a higher
price than the limit, but not a lower one. A limit order
to buy sets a maximum purchase price. The customer prefers
to buy at the lowest possible price, but will under no circumstances
pay more than the limit price.
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Executing a limit order:
The commission broker takes a limit
order to the floor and presents it to the trading crowd, hoping
to get a price better than the limit. Even though there
is a specific price on the limit order, it must be executed at
the most advantageous price for the customer. Limit orders,
therefore, can be executed only at the specified price or better.
If the order cannot be executed at the market, the commission
house broker leaves the order with the specialist, who writes
the trade down in the specialist's order book and watches the
market for that price. Almost without exception, limit orders
are left with the specialist so that they can be executed if and
when price conditions meet the order limitation.
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Risks and disadvantages
of limit orders
Customers who enter limit orders
risk missing the chance to buy or sell, especially if the market
moves rapidly away from the limit. The market may never
go as low as the buy limit price or as high as the sell limit
price. The customer accepts the risk in exchange for extra
control. (This cannot occur with a market order because
it is executed at the current market price.)
Sometimes limit orders are not executed, even if the limit price
is met. There are two possible explanations for this.
- Stock ahead. When there are limit
orders on the specialist's book for the same price, they are
arranged according to when they were received. If a limit
order at a specific price was not filled, chances are that another
order at the same price took precedence; that is, there was
stock ahead.
- Plus (up) tick. Limit orders
to sell short may be executed only on a plus tick or a zero-plus
tick. This means that even if you see a sale on the NYSE
Tape at your price, your limit order to sell short might not
be executed because a plus tick did not occur.
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Stop Orders
A stop order ( also known as a stop
loss order) is a trading tool designed to protect a profit or
prevent further loss if the stock begins to move in the wrong
direction. The stop order becomes a market order once the
stock trades at or moves through a certain price, known as the
stop price. Stop orders are usually left with and executed
by the specialist. There is no guarantee that the executed
price will be as favorable as the stop price. In this way,
a stop order differs from a limit order, which does guarantee
execution at the limit price or better.
In effect, a stop order is a way of saying "Stop the market;
I want to get off (or on)." The stop price triggers
(or elects) the order, which is then normally entered as a market
order. A stop order takes two trades to execute:
- Trigger. The trigger transaction
activates the trade (the trigger transaction must be at or through
the stop price).
- Execution. The execution
transaction completes the trade (the stop order has become a
market order and is executed at the best market price).
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Buy stop order.
A buy stop order is always entered at a price above the current
offering price and is triggered when the market price touches
or goes through the buy stop price. Why would an investor
instruct his registered representative to place a stop order to
"Buy 100 COD at 42 1/4 stop" when the market is at 40?
When COD breaks through the resistance
level of 42 (a bullish event), the investor believes it will keep
going up and hopes to buy at 42 1/4 and ride the stock up.
Until then, his money is not tied up.
Sell stop order.
If the market is at 40, a customer who purchased the stock originally
for $20 a share might call with a stop order to sell at 37 3/4.
In essence, this order says "If the stock breaks through
its support level of 38 ( a bearish event), I think it will keep
going down. At that point, I want out."
Buy stop orders are usually made to limit the risk of short sales.
Sell stop orders are made (1) to protect a profit - for example,
a stock bought at 35 goes to 45; a sell stop order is entered
at 42; and (2) to stop losses - for example, a stock bought at
45 goes to 40; a sell stop order is placed at 38. A sell
stop is also called a stop loss. It makes sense, then, that
a bullish buy stop order will be placed above the market and a
bearish sell stop will be placed below the market.
What if the market really gets away
on a stop? The following example illustrates what could happen.
Assume the market is at 40 and a buy stop is placed at 43.
First the stop is triggered as the stock passes through 43.
The market starts to rise rapidly, and a purchase is executed
at 52. Then the market goes down and stays there for months.
When a large number of stop orders on the specialist's book are
triggered, a flurry of trading activity may take place as they
become market orders. This activity may accelerate the advance
or decline of the stock price. Consequently, the original
intention of a stop order (to curtail a loss or protect a profit)
is sabotaged. Such surprises may be avoided if a limit is
placed on the stop order.
Stop limit order.
A stop limit order is a stop order that, after being triggered,
becomes a limit order rather than a market order. For example,
an order that reads "Sell 100 COD at 52 stop, 51 1/2 limit"
means that the stop will be activated at or below 52. Ordinarily,
the order then becomes a market order, and shares are sold at
the next available price.
However, because there is a 51 1/2 limit, the order to sell cannot
be executed at less than 51 1/2. In essence, the investor
is saying "If the stock price goes down, I'd like to get
out; but if it goes too far, I'd just as soon hang on until it
comes around again."
Again, the execution takes the following order. First the
stop is triggered. Then the trade is treated like any other
limit order that must be executed at the limit price or better.
The buy stop, buy stop limit and sell limit orders are entered
at or above the current market price. The buy limit, sell stop
and sell stop limit orders are entered below the current market
place, as shown in Figure 7.4
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Reducing
Orders
Certain orders on the specialist's
book are reduced when a stock goes ex-dividend, and these are
detailed in the following paragraphs.
All orders entered below the market are reduced on the ex-date
- that is, the first date on which the new owner of stock does
not qualify for the next dividend. On the ex-date, the price
of the stock drops by the amount of the distribution. Orders
reduced include buy limits, sell stops and sell stop limits.
Without this reduction, trading at the lower price on the ex-dividend
date could cause execution. This is illustrated in the following
chart:
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The stop or limit price is reduced
by the next greatest increment of trading; that is, the amount
of the dividend is rounded to the next highest 1/8th.
Do not reduce orders may be entered by a customer. A DNRO
will not be reduced by an ordinary cash dividend only. It
will be reduced for other distributions, such as after a stock
dividend or when a stock trades ex-rights.
Up tick rule. The up tick for the
short sale rule (short sales are covered in the next section)
carries overnight. In the event of a reduction resulting
from a distribution, the prior close is adjusted. For example,
the stock closes on an up tick at 49 and opens ex-dividend the
next day with a 1/4-point reduction (to 48 3/4). A customer
could short the next morning at 48 3/4. This is a zero-plus
tick. If the stock closes at a minus tick or zero-minus
tick, the price the next morning must be 1/8th of a point higher
than the reduced price of 48 3/4 for a short sale to be executed.
Reductions for stock splits (proportional
reductions). To calculate the reduction in the price of an open
buy order or an open stock order after a stock split, divide the
market price by the fraction that represents the split.
For example, if a buy stop order has been entered for a stock
at $100 and a 5-for-4 stock split has been announced, the $100
order price is divided by the fraction 5/4 to find the adjusted
order price of $80.
Calculating Order Adjustments for
Stock Splits
Order price: $100
Stock split: 5 for 4
5/4 = 1.25
$100 + 5/4 = $80
Adjusted order price = $80
Order price: $100
Stock split: 2 for 1
2/1 = 2.00
$100 + 2/1 = $50
Adjusted order price = $50
Order price: $100
Stock split: 3 for 2
3/2 = 1.50
$100 + 3/2 = $66.67
Adjusted order price = $66.625 (66 5/8)
If a calculation results in a price
that cannot be converted exactly into 1/8ths, the order price
is rounded down to the nearest 1/8th.
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Day Orders
Unless marked to the contrary, an
order is assumed to be a day order, valid only until the close
of trading on the day it is entered by the customer. If
the order has not been filled, it will be canceled at the close
of the day's trading. Investors should wait until the end
of the day to change day orders to GTC orders or they will lose
their place for the rest of the day (although if the order doesn't
reach the post in time it will be canceled).
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Good-till-cancelled
(GTC) orders
GTC orders, or open orders, are valid
until executed or cancelled. However, even these orders
have a specific lifetime. Regardless of the day the orders
are entered, the specialist will cancel them on the last business
day of April or October (that is, every six months) unless the
customer renews them at the time (individual firms may clear out
GTC orders as frequently as monthly). This clears the specialist's
books of obsolete orders and reduces the risk of executing trades
that customers have forgotten.
A GTC order that has been properly renewed or confirmed retains
its original position on the specialist's book. If a GTC
order is not renewed or confirmed at the appropriate time, it
is cancelled and must be re-entered as a new order.
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At-the-opening
and market-on-close orders
At the opening orders are executed
at the opening of the market. Partial executions are allowable.
They can be either market or limit orders, but must reach the
post by the open of trading in that security. Market on
close orders are executed at (or as near as possible to ) the
closing. If an at the opening or market at close order does
not reach the post in time, the order is canceled.
Fill
or kill (FOK) orders
The commission house broker is instructed
to fill the entire FOK order immediately at the limit price or
better. A broker who cannot fill the entire order immediately
cancels it and notifies the originating branch office. The
commission house order will not leave the order with the specialist.
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Immediate
or cancel (IOC) orders
These limit orders are
like FOK orders except that a partial execution is acceptable.
The portion not executed is canceled.
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All
or none (AON) orders
These orders have to be executed
in their entirety or not at all. AON orders can be day or
GTC orders. They differ from the FOK's in that they do not
have to be filled immediately.
Penny
Stocks
This page is designed
to provide you, the beginning investor, with general information
about penny stocks and the markets in which they are traded. Because
there is so much fraud involving penny stocks, this booklet serves
mostly to warn potential investors against becoming involved with
penny stocks. However, you should be aware that many small, deserving,
completely legitimate companies issue stock that trades for pennies
a share in the over-the-counter market. The trick is to be able
to spot the potential fraud. We hope this page will help you do
just that.
What
are penny stocks?
There is no set, accepted definition
of penny stock. Some people define it as stock priced under one
dollar, some under five dollars. Some people include only those
securities traded in the "pink sheets," some include
the entire OTC market. The Securities Division considers a stock
to be a "penny stock" if it trades at or under $5.00
per share and trades in either the "pink sheets" or
on NASDAQ. In addition, a true penny stock will have less than
$4 million in net tangible assets and will not have a significant
operating history. (In other words, if a company has real assets,
such as equipment and inventory, and is engaged in some real business,
such as manufacturing, then the Division does not consider the
stock to be penny stock even though the shares are low-priced.)
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The "OTC"
market
Penny stocks are not traded on a
stock exchange, but are traded in the over-the-counter (OTC) market.
Part of the OTC market is the National Market System (NMS) of
the NASDAQ (National Association of Securities Dealers Automated
Quotation) System, which does not include any penny stocks.
There are also non-NMS NASDAQ securities,
including some penny stocks. The NASDAQ system has listing standards
that change from time to time and, depending on the standards,
there may be more or fewer penny stocks on NASDAQ. If you purchase
a low-priced security that is listed on NASDAQ, it will meet certain
minimum standards. In addition, many NASDAQ prices are quoted
regularly in newspapers, allowing you to follow the price of your
security instead of forcing you to rely on your broker for all
price information.
The third major component of the
OTC market is the National Quotation Bureau's (NQB) service, commonly
referred to as the "pink sheets." The NQB's securities
lists and price information, printed on pads of long, narrow sheets
of pink paper, have, for all practical purposes, no meaningful
listing standards, and price information is sometimes difficult,
if not impossible, for the small investor to obtain. Broker-dealers
obtain their price information by calling the trading desks of
three "market makers." Obviously, small investors do
not have access to those traders and must rely on their stockbroker
for accurate price information.
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Principal/Agency
In most securities transactions,
your broker-dealer acts as your agent, arranging a transaction
directly between you and a third party. In compensation for arranging
that trade, you pay your broker-dealer a commission. In some instances,
the broker-dealer has the security you seek to purchase in inventory,
or wants the security you wish to sell. The broker-dealer may
trade with you on its own behalf, as a principal in the transaction.
When the broker-dealer acts as a principal, and not as an agent,
the trade confirmation should say that on its face. The broker-dealer
is not paid a commission in principal trades, but makes its money
on the spread, and by buying and selling at advantageous times,
the same as any other investor. A sizeable portion of penny stock
trades are principal transactions, and an investor should be alert
to the potential conflicts of such transactions.
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Bid/Ask
Penny stocks do not each have a single
price at which they are bought and sold, but a number of different
prices. The first difference is between the bid price and the
ask price. The bid price is how much someone is willing to pay
for the security, or the price at which you could sell your shares.
The ask price is how much someone will sell their securities for,
or how much you will have to pay. The difference between the prices
is the spread.
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The spread
To most investors, the spread represents
a built-in loss at the time of investment. For example, if you
purchased a stock that traded at 1/2 cent bid, 1 cent ask, the
bid would have to more than double in price for you to break even
(the "more than double" comes from additional costs
such as "ticket" charges and other miscellaneous costs).
Many investors buy penny stocks believing that "trading at
12´ cents" means that they can buy and sell at 12´ cents.
This simply is not the case, and any salesperson who uses such
a phrase is only telling half of the truth. The spreads in penny
stocks are most commonly 25-33%, are often 50-100% and sometimes
are over 100%.
Another factor to keep in mind when
evaluating price information about penny stocks is that there
are two "bid" and two "ask" prices, the inside
and outside bid and ask. As a general rule, the price you will
be interested in will be the outside bid and ask, or the lower
bid and the higher ask, as those are the bid and ask prices to
public customers.
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Mark-ups
The last pricing factor concerning
penny stocks is called the mark-up. A broker-dealer who has held
the security in its account and subject to the risk of market
price fluctuation, may mark the price of the security it sells
to you up by a certain percentage, on top of the spread. This
is to compensate broker-dealers for maintaining inventory sufficient
to supply demand for an orderly and liquid market. What it means
to the average investor is another cost that creates a built-in
loss at the time of investment. In other words, the instant your
transaction is effected, your securities are worth less than you
paid for them.
Although it is no guarantee of a
good price, you are more likely to get a better price in an agency
transaction using a broker-dealer that has no interest in the
transaction, due to the pricing factors above. In the typical
penny stock transaction, the broker-dealer buys from its customers
at the bid and sells at the ask, capturing as compensation the
spread, plus any mark-up.
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Market makers
A market maker is a broker-dealer
who stands ready to buy or sell 100 shares of the stocks in which
it makes a market. When a transaction is proposed, the market
maker will give a price at which it would be willing to effect
that transaction. The market maker's price applies only to the
first 100 shares. While the market maker system has been widely
criticized (after all, how much of a commitment is it to buy 100
shares at a penny apiece?) the system does offer investors some
level of fairness. The more market makers there are in a given
stock, the more likely they are to bid against each other, and
the price will more likely move to a true "market" price.
The names of the market makers of securities traded in the pink
sheets are listed in the pink sheets.
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Manipulation
Especially when there are few or
only one market maker, penny stocks are susceptible to price manipulation.
A common and easy manipulation is for a broker-dealer to gather
a large holding of a penny stock at a very low price. Through
the use of high-pressure sales techniques, the sales force of
the broker-dealer hypes the stock and stirs up demand, which seemingly
justifies the continual rise in prices given by the broker-dealer
(which is probably also the only market maker).
The price continues to rise until
there are no more investors who will buy, and then the bottom
falls out and the price plummets. Sometimes the broker-dealer
will buy back the securities at the fallen prices to recapture
the stockpile for a future revival of the stock; more often investors
are simply left holding the worthless stock.
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Initial
public offerings
The price and market discussion above
relate to penny stocks already trading in the market. Stocks are
introduced into the market through an initial public offering
(IPO). In most cases, an IPO would need to be registered with
the Securities Division, which applies a set of guidelines to
the offering to determine whether the offering is "fair,
just and equitable." Although the "merit" system
of applying those guidelines is not foolproof, fraudulent offerings
are rejected and not granted registration. For this reason, Missourians
are not usually victims of penny stock scams in an IPO, but lose
their money in the secondary market. In the secondary market,
there are broad exemptions in the law that allow many penny stocks
to trade in Missouri without meeting the merit standards.
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Legitimate
penny stocks
Despite all of the problems with
penny stocks and the millions of dollars of loss involved with
them, there are legitimate companies whose securities trade in
the pink sheets at very low prices. Struggling young companies
just starting out are perfect examples. Investment in such a company,
held through the company's formative years, can pay off well.
Such an astute investment requires three things: the ability to
choose the right company, the capital to invest and hold the investment,
and luck.
In order to choose the right company,
you must know something about the business in which the company
engages. You must be able to evaluate the feasibility of the company's
business plan and the company's ability to compete in its field
of endeavor. You must be able to evaluate the ability of the company's
management to run the company. Finally, you must be able to evaluate
the capitalization and cash flow of the company.
If you find the right company, you
must be able to hold the investment for years to allow the company
to mature and for the stock to appreciate in value. Investment
in "growth" companies is long-term investment. Furthermore,
you must have sufficient capital to be able to withstand total
loss of your investment. Investment in emerging companies is always
a high-risk investment.
Finally, there is simply an element
of luck in any stock investment. Luck plays an even greater role
in a market in which manipulation is so prevalent. Some legitimate
companies have had their stocks manipulated to such an extent
that they were forced out of business. Even without manipulation,
the success or failure of a fledgling business is simply unpredictable.
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Sources
of information
Your broker can be a tremendous help
in evaluating an investment. However, in the penny stock area,
there are many unscrupulous brokers whose only goal is to sell.
Be sure that the advice you receive is balanced and addresses
your investment needs. When in doubt, avoid a penny stock investment,
especially if your broker "specializes" in penny stocks.
The prospectus is the most comprehensive
source information about an IPO. It sets out where your investment
money will be used, describes the capitalization, history and
management of the company and describes the cash flow system of
the company. If you need help interpreting the information you
find in the prospectus, the Division has another pamphlet in this
series entitled "How to Read a Prospectus."
Trade confirmations contain a wealth
of information. The confirmation will show basic information,
such as number of shares, but will also indicate whether the transaction
was agency or principal, was solicited or unsolicited (it will
say "unsolicited" if you called your broker to place
the order without your broker having tried in any way to get you
to place the order) and, in the case of most pink sheet and non-NMS
NASDAQ trades, provide the bid and ask at the time of execution
of the transaction.
Manuals such as Moody's and Standard
and Poor's have current financial information about companies,
and most penny stocks are listed in the manuals.
Periodic reports filed with the U.S.
Securities and Exchange Commission have updated information about
companies that register with the SEC. The most common report is
a "10-K."
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Warning signs
Watch for the following warning signs
to alert you to a possible penny stock fraud:
High-pressure sales techniques. Investment
in a legitimate emerging company is long-term. A good little company
is not going to skyrocket in a couple of weeks. Building a sound
company takes years; you have a few days or weeks to decide whether
the investment is right for you.
Blind pools and blank checks. Do
not invest in any security without being told exactly how your
money will be spent. Be sure you know which properties the company
plans to buy with the offering proceeds and how much money is
to be spent on management and promoters.
Mismarked trade confirmations or
new account cards. Be very wary if your trade confirmation is
marked "unsolicited" if your broker did, in fact, solicit
the trade. While it may be a simple mistake, unscrupulous penny
stock brokers often mark the confirmation as unsolicited to avoid
the registration laws and the "fair, just and equitable"
standard. Watch for misstatements about your net worth, income
and account objectives as well. Investing in penny stocks is speculative
business and involves a high degree of risk. Often, brokers will
enhance the new account card to make it seem that you are suitable
for a penny stock investment when you are not.
Unauthorized transactions. Be alert
to placement in your account of securities you did not agree to
purchase. In some instances, a broker may try to pressure you
into purchasing the stock, claiming that since you have the stock,
you must pay for it. In some cases, the broker is temporarily
"parking" the securities in your account, perhaps to
meet the minimum distribution of an IPO, or for any number of
reasons. In some cases, an unauthorized trade is simply a mistake,
but in any case, complain immediately, both verbally and in writing
to your broker, your broker's manager and to the Securities Division.
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