Fast Markets
Monday, December 27, 2010
, Posted by the InCrediBLe at 7:20 AM
You've probably heard about "fast markets" in the news. But what does it really mean? What are
the dangers of a fast market? How can you protect yourself as an investor?
We will discus the following topics related to fast markets:
- A Fast Market in Action
- How It Starts
- Protecting Yourself in a Fast Market
- Market Order, Stop Order, Limit Order...What's the Difference?
- Be Aware of How the Trading Process Works
- Timing is Everything
A Fast Market in Action
A fast market is an event that's becoming increasingly common: A hot new technology company
goes public. Within minutes of opening the Initial Public Offering (IPO) on secondary markets,
investors from around the country are online trying to get a piece of the action. With only a limited
number of shares of the small company available, the stock price skyrockets.
Or there's the opposite scenario: A popular stock disappoints investment analysts or fails to meet
projected earnings. By the close of market, its stock price has been sent tumbling by investors
eager to unload it from their portfolios.
Up and down, volatile stocks have been spiking in both directions — sometimes as much as 10%
to 50% — in the course of a day or even a few hours. While this kind of fast market activity has
spelled success for some investors, it has meant disastrous results for others.
In a fast, high-volume trading environment, the price of a stock can change so quickly that by the
time a real-time quote on the computer screen is updated, it's already history. The result can be
market order execution prices drastically different from what an investor expected.
How It Starts
News about a company hits the wires, like:
- An Initial Public Offering (IPO).
- Change in a company's earnings, positive or negative.
- Recommendation by an analyst or publication.
Trading Gets Heavy
- Internet, phone and broker orders pour in.
- The balance of trade orders is upset with more "buys" than "sells" or vice versa.
Order Executions Are Delayed
- Orders are placed so fast, a backlog may develop.
- Trades are lined up in a queue and executed in the order received.
Systems Can Overload
- Market Makers turn off auto-execution systems and revert to manual order handling procedures in which execution of trades is on a "best efforts" basis. The trading process slows down and the "reasonable time" it takes to execute an order can greatly increase.
- Orders are often subject to partial fills at various prices.
- Trade reports are delayed so investors checking their accounts don't know if their trade was executed. Trying to change or cancel orders may result in duplicate orders or orders that arrive too late to halt the trade.
- Sometimes volume is so heavy that access to brokerage web sites can slow down or be unavailable.
Prices Fluctuate
- Price of the limited number of shares available can change quickly as demand grows.
- Trades executed first in the queue can influence the price of subsequent orders waiting behind them.
- Quotes — including real-time quotes — can't keep up with the huge trading volume and lag far behind actual market prices.
By the time a market order is executed, the stock price may have skyrocketed or plummeted far
beyond what the investor expected — as much as 50% or more.
Protecting Yourself in a Fast Market
The only surefire way to protect yourself in a fast market is to stay out of it. If you feel you must
trade during a fast market there are a few things you can do to protect yourself.
Place a Limit Order
When trading a volatile or new stock, you can reduce your risk by placing a limit order specifying
the maximum you're willing to pay to buy a stock or the minimum you'll accept to sell a stock.
Unlike a market order, which is an order to buy or sell at the best available price when the order is
received in the marketplace, a limit order gives you price protection by ensuring you get your limit
price or better. There's no guarantee your trade will be executed, but it's the most effective
strategy for limiting your risk.
Market Order, Stop Order, Limit Order . . . What's the Difference?
A market order is an order to buy or sell a stock as soon as possible at the best price available.
In a fast market situation, a market order can be very risky.
A stop order is an order to buy or sell a stock when the price reaches or passes a specified point
(the stop price). When that happens, a stop order automatically becomes a market order and is
executed at the best price available. In fast markets, however, after a stop order hits the stop
price and becomes a market order, it can keep climbing or drop sharply - and ultimately be
executed much higher or lower than originally specified.
A limit order is the safest way to trade in a fast market because it's an order to buy or sell a
stock only at the specified price (the limit price) or better.
Know What You're Buying
What do you know about the company you're buying? Have you researched it? Buying a stock on
impulse or hearsay isn't smart investing. Be sure the company you're buying a piece of is one you
really want.
Be Aware of How the Trading Process Works
Educating yourself about investing is an ongoing process. If you're a new investor or need a
review of trading procedures, pick up a book like The Wall Street Journal Guide to Understanding
Money and Investing, take a virtual trip to the New York Stock Exchange on the Web at
www.nyse.com (click on Education), or locate an investing club in your area through the
American Association of Individual Investors at www.aaii.com.
Stay on Track with Your Investment Strategy
When you're considering a stock, first see if the company meets your investment objectives. If
you haven't formulated an investment strategy yet, now is a good time to start. Begin by
determining your goals and your time horizon, then choose the investments that will best meet
them.
Weigh the Risk . . . Before You Click
Before you place a market order for a volatile stock, ask yourself how much you could afford to
lose in the event of sweeping price fluctuations. Don't risk spending more than you can afford.
Timing Is Everything
If you're planning to place an opening market order, make sure your order is entered before 9:20
a.m. Eastern Time. Otherwise, your order may not queue until after the pre-open is completed. At
the end of the day, enter market orders at least 10 minutes before closing or your order may not
be executed.
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