Saturday, February 13, 2010

Placing Orders and Market Integrity

Have you ever placed an order and wondered why it was mysteriously cancelled or rejected by your broker? It can be a source of frustration for traders especially when they plan to buy a stock, the order does not execute and then the stock price takes off with the trader scratching his head at the lost opportunity. This article hopes to clarify the valid reasons for these rejected orders and also to suggest ways that traders can possibly avoid the scenarios explained.

Each market participant (or broker) has a responsibility to the ASX to ensure they assist in maintaining fair and orderly markets. In doing so, online brokers will have a system of filters or vetting rules that will refer orders to a Designated Trading Representative (DTR) should an order fail a filter. A DTR that is trained in this area will have the order show up on their screen and ultimately decide if the order is acceptable and sent it to market or reject if it is unacceptable. Traders may have noticed that sometimes their order may not hit the market depth right away or that it is showing up as a ‘referred order’ online – this delay is probably the case of the order failing a filter and it being forwarded to the DTR who is in the process of reviewing it. Traders may find this irritating if they wish for their order to be executed immediately on a quick moving stock.

So what are some of the filters and what are they designed to do? Online brokers can have up to hundreds, most of which are setup to maintain a fair market but some also to protect their clients. I will now proceed to list some of the reasons filters are established:

*Unmarketable parcel – The ASX specifies that an investor must buy at least a $500 minimum parcel of shares should he/she not already hold shares in that company. This filter is setup to ensure that buy trades with a consideration of less than $500 are not executed. It must also be noted that brokers must not allow a client to enter a trade knowing that it could possibly result in the client having a holding of less than $500 worth of shares. For example, if the client has a $1000 holding and wishes to sell $700 worth of shares.

*Traded too much of a particular company on that day – I’m unsure if there are filters to prevent this from occurring however there are situations when a DTR must monitor this type of situation. It obviously does not affect companies that are highly illiquid and may have a few small trades a day, however, if a company trades for example $200,000 worth of shares and of that one trader trades $100,000 worth and over numerous trades than it is something that the DTR and compliance department may have to discuss and monitor.

*Data entry error – There are occasions where we all make a ‘typo’, suffer from ‘fat fingers’ or simply put the decimal point in the wrong place. For example, a trader may wish to place an order to buy stock XYZ at $0.30 but instead enters $3.00 which is clearly an error. These orders are easily picked up by the filters and rejected by the DTR.

*Padding/Stacking the market – This occurs when a client enters numerous orders on the same stock on the same side (either buy or sell side) of the market. For example a client may place orders to buy stock XYZ at $0.40, $0.41, $0.42 and $0.43. All of these show as separate orders in the market depth and give a false sense of there being numerous different buyers for that particular stock. It is for this reason that many brokers will have a limit of 3 orders per client per stock on the same side of the market.

*Trading with yourself (user crossing) – This one seems a bit unusual but the filters do sometimes prevent this from happening. An example of when it may occur is when a trader has an existing order in the market to buy or sell shares which they may have forgotten about and then enter an order on the opposite side that would match their existing order (thus resulting in the trader trading with themself). Also, at the end of the financial year traders may attempt to trade with themselves to crystallise a tax loss especially if the market for that stock is illiquid and they cannot trade with another trader in that stock. At the end of the day, a trade cannot be executed if there is no change in beneficial ownership of the shares.

*Overlapping by too much – Your order may be rejected if it is overlapping the opposite bid/ask by too greater margin. For example, if the bid of a stock is at $0.40 and you place an order to sell your stock at $0.30. Overlapping the market can be a tricky game and a useful tactic when a trader is attempting to get price priority during a pre-open period (whether this be before the market has opened or whilst an announcement is about to be released). Rather than attempting to get at the very top of the queue with your bid/ask during the pre-open phase it is probably more wise to place your order at the same price as that of somebody already at the top of the queue. The reason for this is because your broker will be happy to place the order for you if another broker has already set a precedent rather than take on the risk of being the first broker to approve such an order.

*Too far from market – Orders which have no chance of trading as their bid or ask is too far from the last traded price can be rejected. Those orders which the DTR deem as okay and places may still be purged from the market by the ASX overnight. An example includes submitting a bid at $0.03 when the stock is trading at $0.20.

*Moving stock too much – One trade cannot move a stock price by a too greater margin. Brokers will usually have filters that refer any order that will move the stock price by over 10%. An example may be if a stock last traded at $0.60 and you place an ‘at market’ buy order which will execute at $0.73. There is a legitimate way to get around this and that is to place a ‘limit order’ at say $0.64 and slowly increase your bid every so often until you meet the seller at $0.73. Brokers will look more favourably upon this as it is giving the market time to respond to the change in conditions.

*Artificial closing price/Marking close – The last traded price at the end of the day is the price that is quoted in the newspapers or will be the price that the change will be calculated on the next day. For this reason sometimes traders (holding the stock) will try and make the close quite a bit higher then what the stock really has been trading at on average on that day. Marking the close is more critical at the end of the month or quarter as it will be when fund managers, company directors or top shareholders are reporting share prices for those stocks they are holding. The higher the stock price than the better the performance of their investments they can report.

*Wiping out the market – On a stock that has a thin market depth one order cannot wipe out many price steps in one hit. For example, if a stock last traded at $0.42 and a trader wishes to execute an order to buy 50,000 shares at $0.50 with the following market depth:


5,000 @ $0.43

17,000 @ $0.445

20,000 @ $0.45

3,000 @ $0.48

40,000 @ $0.50

This is a type of order that would be cancelled as the trader would be wiping out numerous price steps at $0.43, $0.445, $0.45, $0.48 and pushing the price up to $0.50 (the final 5,000 units of the order would trade at $0.50)

*Duplicate order – Sometimes a trader will receive a message that states ‘You have placed a similar order within the last few minutes, do you still wish to place this order?’ This message is attempting to ensure that an order isn’t duplicated by a trader in error. It is useful if the trader’s internet connection is failing during placing the order and he/she thinks the order did not go to market (when in fact it did) and thus attempts to place another one.

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