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Financial Literacy

What You Need to Know About the NYSE’s New Trading Rule

On February 26 of next year, the New York Stock Exchange will join the Nasdaq and institute a rule that will absolutely affect the way you place buy and sell orders…

You will no longer be able to enter stops or good ‘til canceled (GTC) orders.

A stop order is an order sent to the exchange that is executed when a stock trades at a specified price. For example, if you own Pfizer (NYSE: PFE) at $32 and don’t want to risk more than 25%, you would place a stop at $24.

If Pfizer drops to $24, your order would be executed at the next available price.

This has caused problems in recent years, during periods of high volatility – like when the market had that flash crash back in August. In our example with the $24 stop, if the market were undergoing another crash, the price might fall so fast that your stock gets sold below $24.

And the New York Stock Exchange says that stop orders actually increase volatility. When the market falls hard and all those stops gets hit, it only adds to the selling pressure.

Additionally, having a stop in place is like playing cards with your hand exposed. The market can see what you want to do…

Sticking with our Pfizer example, if the share price has drifted lower and is now trading at $24.05, the market makers know that you have a stop in place at $24. (They are sent the order when you place it with your broker.) So they might just gun for your stock and bring the share price of Pfizer down to $23.95.

This would force you to sell your shares to them at an artificially lower price. Moments later, the stock is back to $24.05, and they’ve made a quick and easy $0.10 per share.

That’s the negative aspect of stops. Of course, most of the time they are useful.

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The Oxford Club is a big advocate of using stops because they take the emotion out of selling. The sell order is placed when you buy the stock – not when it is dropping and your emotions are trying to justify why you should hang on to the stock a little longer.

Stops allow us to cut our losses before they become too large. We also raise the stops when stocks climb, which lets us take profits without letting greed take over.

But with its new rule, the New York Stock Exchange is actually doing you a favor. Even though I like the concept of stops, the fact that the market can see what we want to do ahead of time has never sat right with me. That’s why, for years, I’ve been advocating that investors use a different type of order.

Now, you’ll have to use one of these orders if you want to use a stop.

Each broker has a different term for it. TD Ameritrade calls it a Trade Trigger. Schwab calls it a Conditional Order. E-Trade named it a Hidden Stop Order.

These orders are similar to stops, but instead of being sent to the market when you place the order, the order stays with your broker. Only when your specified price is hit is your order sent to the market.

The disadvantage is that it might take a second or two more to get the order to the market. So, in a fast-moving market, your price might be lower than you hoped for.

But the benefit is you are no longer tipping your hand to the market – so there is less chance of manipulation.

Call your broker and find out how they plan on addressing this new rule. If they don’t have a type of order to replace traditional stops, consider switching brokers.

The NYSE and Nasdaq are also getting rid of GTC orders, which leave orders out there in perpetuity. So you could have a buy or sell order at a specific price forever. If Pfizer is trading at $35 and you want to buy it only at $32, previously you could put a buy limit at $32 – good till canceled.

Now, similar to the alternate stop orders held with your broker, good till canceled orders will likely be held with your broker as well – not with the exchanges.

Contact your broker now about switching any stop or GTC orders so you don’t forget about them on February 26 when those orders will be eliminated.

Overall, these are good changes that should decrease volatility (slightly) and manipulation. But it requires you to be a bit more active in understanding what types of orders your broker offers and making sure they have the kinds of orders that will fit your needs.

Good investing,

Marc


About

A master of the steady, reliable science of income investing, Marc’s commentary has appeared in The Wall Street Journal, Barron’s and U.S. News & World Report. He has also appeared on CNBC, Fox Business and Yahoo Finance. His book Get Rich With Dividends: A Proven System for Double-Digit Returns achieved best-seller status shortly after its release in 2012. He captures the hearts and minds of readers approaching their golden years in his daily e-letter, Wealthy Retirement.

 

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