Stock Volatility and On-line Trading
Stock Volatility and On-line Trading
With a few keystrokes and a click of the mouse, investors today can buy or sell stocks through on-line trading accounts with the same ease as they search the Internet or play computer games. Investors’ on-line access has grown dramatically in the last several years, with more than 100 brokerage firms now offering on-line trading services.
Investors need to bear in mind that while the mechanics of on-line trading are relatively easy--investing is not. It is important not to confuse the procedure for entering an order—which can be executed with the push of a button—with making thoughtful investment decisions. Investors should exercise the same degree of care when trading on-line that they do when making any other investment decision.
During periods of increases in price volatility and volume, investors should be aware of firms’ practices under such conditions. Below is a brief discussion of the areas that may be affected during such periods. Also, please see Notice to Members 99-11, which suggests disclosures firms should make to retail customers to educate them about the risks of price and volume volatility, and Notice to Members 99-12, which provides FINRA members with guidance concerning the operation of their order execution systems and procedures during extreme market conditions.
During these periods of increased price volatility and record trading volume, customers eager to trade Internet stocks have flooded their brokers with large numbers of orders, leading to large order imbalances, system queues, and backlogs. Investors should be aware that, during these extreme market conditions, many firms have implemented procedures that are designed to preserve the continuous execution of customers’ orders while also decreasing the exposure of the firm to extraordinary market risk. For example, some Market Maker firms temporarily discontinued normal automatic order executions and handled orders manually. Firms also reduced their size guarantees on individual stocks or groups of stocks (i.e., stocks of Internet issuers) on a going-forward basis.
What Investors Should Ask Their Brokers
It is important that investors educate themselves about how securities transactions are executed, particularly during times of volatile prices and high volume. Before opening an online account or placing the first trade, investors should ask on-line firms a number of questions so they can make appropriate investment decisions.
High volumes of trading at the market opening or intra-day may cause delays in execution and executions at prices significantly away from the market price quoted at the time the order was entered. Investors should ask firms to explain how order executions are handled by Market Makers, particularly when the market is volatile. It is particularly important for online investors to make this inquiry, since most have come to expect quick executions at prices at or near the quotes displayed on their computer screens.
Types of Orders
Investors should ask the firm they are working with to explain in detail the difference between market and limit orders and the benefits and risks of each. In particular, firms are required to execute a market order fully and promptly without regard to price. In some market conditions, execution may be at a price significantly different from the current quoted price of that security. Limit orders will be executed only at a specified price or better. Customers using limit orders receive price protection, but there is the possibility that the order will not be executed.
As a related matter, if you are investing in initial public offerings trading in the secondary market, particularly those that trade at a much higher price than their offering price, or in "hot stocks" (those that have recently traded for a period of time under what is known as "fast market conditions," in which the price of the security changes so quickly that quotes do not keep pace with the trading price of the stock), you should be aware that your risk of receiving an execution substantially away from the market price at the time you place your order may be significantly reduced if you place a limit order.
You should be aware that you may suffer market losses during periods of volatility in the price and volume of a particular stock if there are delays in effecting buy or sell orders. You may have difficulty executing your trades due to limitations on system capacity. In addition, if you are trading on-line, you may have difficulty accessing your account due to high Internet traffic. Customers trading through brokers at full-service or discount brokerage firms or through representatives of on-line firms when on-line trading has been disabled or is not available may have difficulty reaching account representatives on the telephone during periods of high volume. You should ask your firm to explain its procedures for responding to these access issues.
Communications with the Public
Investors may see a firm using advertisements or sales literature to make claims about the speed and reliability of their trading services. These communications with the public must not exaggerate the broker-dealer's capabilities or omit material information about the risks of trading and the possibilities of delayed executions. Moreover, broker-dealers should have the systems capacity to support any claims they make about their trading services. Misrepresentations or omissions of material facts in public communications violate FINRA rules. You should ask your firm whether it has adequate systems capacity to handle high volume or high volatility days.
Basically, investors should be aware and armed with adequate information, particularly before engaging in on-line trading activities. The market is an ever-changing environment, making it more important than ever for investors to use investing tools they understand. Get to know the firm you are dealing with, and make sure that when you choose to trade online, you do so commensurate with your investment objectives and ability to tolerate investment risks.