Trading Markets Basics Flashcards
All of the following statements are true about Regulation NMS EXCEPT:
A. the “Order Protection Rule” requires that all orders be protected and receive the best execution price during normal market hours
B. market makers are obligated to display customer limit orders at the same or better price than the market maker’s quote
C. all exchange listed, NASDAQ and OTC stocks are subject to the rule
D. quotes from all markets must be consolidated to display a National Best Bid and Offer (NBBO) for each covered security
The best answer is C.
Regulation NMS requires all market centers to electronically link and provide automated execution at the best price of all markets within 1 second for orders that are executable. It mandates that market centers cannot discriminate against customers who access their quotes. It requires that markets have procedures in place to prevent trade-throughs - which is “trading through” another market’s better priced quote (the same thing as executing an order at an inferior price in that market). This is called the Order Protection Rule (Rule 611).
Regulation NMS requires market makers to display all customer orders that are at the same or better price than the market maker’s price. This is called the Limit Order Display Rule (Rule 604). Thus, market makers cannot bury customer orders and must show all trading interest.
Regulation NMS only applies to exchange listed and NASDAQ stocks. These are called the NMS stocks. It does not apply to OTC stocks - therefore Choice C is incorrect.
Regulation NMS required market centers to do all of the following EXCEPT:
A. electronically link and make quotes accessible in real time
B. provide for automated execution at the best price within 1 second
C. execute all short sales on stocks that are declining in price on an up bid
D. put procedures in place to prevent trade-throughs
The best answer is C.
Regulation NMS requires all market centers to electronically link and provide automated execution at the best price of all markets within 1 second for orders that are executable. It mandates that market centers cannot discriminate against customers who access their quotes. It requires that markets have procedures in place to prevent trade-throughs - which is “trading through” another market’s better priced quote (the same thing as executing an order at an inferior price in that market). The rules surrounding short sales are covered under Regulation SHO - not Regulation NMS.
The “trade-through” rule of Regulation NMS:
A. prohibits an order from being routed to a market that will pay for the order
B. prohibits a market maker on an exchange from executing a trade at an inferior price to that posted by another market at that moment
C. requires member firms to execute any order received within 1 second of execution
D. requires member firms to use automated clearing and settlement of all trades
The best answer is B.
The trade-through rule of Regulation NMS requires that any “fast market” (NYSE, AMEX (now renamed the NYSE American) and NASDAQ) must either execute a trade within 1 second at the best price posted for a given security at that moment; or must route that order to the market that is posting the better price (this could be a Third Market Maker or an ECN). Thus, market makers are prohibited from “trading through” another market’s better priced quote.
Under SEC Rule 605 of Regulation NMS, market centers, in their monthly reports on order execution, must disclose which of the following information?
I Fill rates
II Speed of executions
III Rates of price improvement
IV Trading Volumes
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is C.
SEC Rule 605 of Regulation NMS requires that market centers prepare, and make available to the public, monthly standardized reports summarizing their order executions. Included in the report is data on: Effective spreads (narrow spreads are better!); How market orders of various sizes were executed relative to the public quote (executions at, or very close to the public quote are better!);
Speed of execution (fast execution is better!);
Fill rates (a larger percentage of orders being filled is better!); and
Price improvement or disimprovement (getting a better price than expected is better!).
Trading volumes are not included in the monthly report on execution quality required under Rule 605 because trading volumes are reported every day by the exchanges.
Under SEC Rule 606 of Regulation NMS, broker-dealers are required to compile statistical information on routing of customer non-directed orders to market venues, and make this information available to customers:
A. monthly
B. quarterly
C. semi-annually
D. annually
The best answer is B.
SEC Rule 606 of Regulation NMS requires broker-dealers to compile and report statistical information on their order routing procedures for all customer trades every quarter. Do not confuse this with another part of the rule that requires that broker-dealers give to their customers an annual notice that the customer can, on request, get detailed information on the routing of that customer’s orders over the prior 6 months.
Under SEC Rule 606 of Regulation NMS, the required quarterly report on order routing methods includes information on which of the following?
I Directed orders for listed equity securities
II Non-directed orders for listed equity securities
III Directed orders for NASDAQ securities
IV Non-directed orders for NASDAQ securities
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
SEC Rule 606 of Regulation NMS requires broker-dealers to do the following:
The fact that the firm received a payment for order flow must be disclosed on the customer trade confirmation.
The firm, on request of the customer, must disclose the identity of the market to which the customer’s orders were routed for execution in the preceding 6 months along with the time of execution. (These are known as “non-directed” orders, since the customer did not tell the broker the specific market where the order was to be executed, so the member firm could route the order to wherever it wanted.)
The firm must notify customers, in writing, at least annually, of the availability of this information.
In addition, the rule requires member firms to prepare a quarterly report that is publicly available that details the:
Percentage of customer orders that were “non-directed;”
Identity of the 10 largest markets or market makers, to whom non-directed orders were routed and any other venue that received 5% or more of the firm’s orders;
Member firm’s relationship with that market maker (for example, many larger retail member firms own their own market maker subsidiaries to whom they route orders); and
Arrangement, if any, for payment for order flow or profit-sharing.
Because of this rule, member firms cannot have “hidden” arrangements with market makers to favor them in return for “payment for order flow” - everything is out in the open and is fully disclosed. Thus, customers can make informed decisions about how retail member firms are routing and executing their orders.
Note that Rule 606 does not apply to “directed orders” where the customer specified the market venue to which the order was sent.
The rule applies to “non-directed” orders for exchange listed stocks and exchange listed options and NASDAQ securities. It does not apply to executions of trades of OTCBB or Pink Sheet stocks.
Which statements are TRUE?
I Orders and quotes for NMS stocks can only be accepted or posted in penny increments in exchange display books
II Orders and quotes for NMS stocks can be accepted or posted in sub-penny increments in exchange display books
III Trade executions of NMS stocks can only occur in penny increments
IV Trade executions of NMS stocks can occur in sub-penny increments
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Rule 612 of Regulation NMS does not allow sub-penny orders to be entered for NMS (NYSE, NYSE American (AMEX) or NASDAQ) stocks. However, trade executions are permitted in sub-penny increments, since this makes the market more competitive.
An NMS stock is current quoted at $16.10 Bid - $16.30 Ask. A customer wishes to place an order to buy 1,000 shares of the stock at $16.111. The registered representative should:
A. refuse to accept the order
B. route the order to an ATS
C. route the order to an exchange
D. accept the order and round the price to $16.11
The best answer is A.
Rule 612 of Regulation NMS does not allow sub-penny orders to be entered for NMS stocks. The order must be refused under SEC rules (or the representative can tell the customer to enter it as $16.11, but this is not given as a choice).
An NMS stock is currently quoted at $15.20 Bid - $15.40 Ask. A customer wishes to place a limit order to buy 100 shares of the stock at $15.211. The registered representative should:
A. reject the order
B. route the order to an Alternative Trading System
C. route the order to an exchange
D. accept the order and round the price to $15.21
The best answer is A.
Rule 612 of Regulation NMS does not allow sub-penny orders to be entered for NMS stocks. The order must be refused under SEC rules (or the representative can tell the customer to enter it as $15.21, but this is not given as a choice).
If a customer directs that a marketable order be sent to a specific trading venue, then the trade must be:
A. rejected
B. sent to the NYSE for execution
C. sent to the market specified by the client
D. sent to the market with the largest display size
The best answer is C.
If the customer directs that the trade be sent to a specific trading venue, follow the customer’s instructions. When the trading venue gets the order, it must either fill the order at the best price available in all markets; or it must re-route the order to the better-priced market (the “trade-through” rule); so the customer will get the best price, no matter where the order is actually sent!
A technical analyst has been charting the price movements of ABC stock. The stock has been fluctuating in price between $56 and $61 per share for the past 3 months. If the analyst expects a breakout through the support level, which order should be placed?
A. Sell (Short) ABC @ $62 Stop GTC
B. Sell (Short) ABC @ $61 GTC
C. Sell (Short) ABC @ $56 Stop GTC
D. Sell (Short) ABC @ $55 Stop GTC
The best answer is D.
If a stock moves through a support level, it is breaking out to the downside. In this example, the support level is at $56. If the stock moves through this price, it is expected that it will move sharply downward. To sell below the current market, a sell stop order must be used. Therefore, the order to sell (short) ABC @ $55 Stop GTC is appropriate. This would be a short sale (the sale of borrowed shares), so that these shares could be purchased at a lower price after the market drops and used to cover the short position at a profit. A sell limit order cannot be used, since these are orders to sell higher than the current market.
If a technical analyst believes that a stock will break through a “resistance” level, the analyst:
I believes that the stock price will fall
II believes that the stock price will rise
III will place a buy stop order
IV will place a buy limit order
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
A stock breaks a “resistance” level as the market rises. If the stock breaks the stop price, the investor feels that the price will “go to the moon” - that is, rise rapidly. To profit, he wants to buy - but he only wants to buy if the market goes ABOVE the resistance level - the order he places is a buy stop. The order must be a buy stop because it is placed higher than the current market. If the market rises to the stop price, the order is triggered and becomes a market order to buy. Once the long stock position is established, the customer believes the price will skyrocket, so that it can be sold at a higher price for a profit. A buy limit order cannot be used because it is placed lower than the current market price.
A technical analyst has been charting the price movements of ABC stock. The stock has been fluctuating in price between $41 and $46 per share for the past 3 months. If the analyst expects a breakout through the resistance level, which order should be placed?
A. Buy ABC @ $40 Stop GTC
B. Buy ABC @ $41 Stop GTC
C. Buy ABC @ $46 Stop GTC
D. Buy ABC @ $47 Stop GTC
The best answer is D.
If a stock moves through a resistance level, it is breaking out to the upside. In this example, the resistance level is at $46. If the stock moves through this price, it is expected that it will move sharply upward. To buy above the current market, a buy stop order must be used. Therefore, the order to buy ABC @ $47 Stop GTC is appropriate. Once the long stock position is established, the customer believes the price will skyrocket, so that it can be sold at a higher price for a profit.
A technical analyst has identified a resistance level for ABC stock at $50 and a support level at $40. The stock is currently trading at $45 and the analyst expects a breakout on the upside. What order is appropriate to profit from this movement?
A. Buy 100 ABC @ Market
B. Buy 100 ABC @ $49 Stop
C. Buy 100 ABC @ $51 Stop
D. Buy 100 ABC @ $51
The best answer is C.
A stock breaks a “resistance” level as the market rises. If the stock breaks this level ($50), the investor feels that the price will rocket upwards. To profit, he wants to buy if the market breaks $50 on the upside, so the order is to buy @ 51 Stop. The order must be a buy stop because it is placed above the current market. If the market rises to $51, the order is triggered and becomes a market order to buy. The order can then be executed on the next trade. Once the long stock position is established, the customer believes the price will skyrocket, so that it can be sold at a higher price for a profit.
A technical analyst has been charting the price movements of ABC stock. The stock has been fluctuating in price between $49 and $54 per share for the past 3 months. If the analyst expects a breakout through the resistance level, which order should be placed?
A. Buy ABC @ $48 GTC
B. Buy ABC @ $48 Stop GTC
C. Buy ABC @ $55 GTC
D. Buy ABC @ $55 Stop GTC
The best answer is D.
If a stock moves through a resistance level, it is breaking out to the upside. In this example, the resistance level is at $54. If the stock moves through this price, it is expected that it will move sharply upward. To buy above the current market, a buy stop order must be used. Therefore, the order to buy ABC @ $55 Stop GTC is appropriate. Once the long stock position is established, the customer believes the price will skyrocket, so that it can be sold at a higher price for a profit. A buy limit order cannot be used, since these are orders to buy lower than the current market.
