As with all high-frequency financial trading, speed is the most critical factor. In a lightning-speed market, the integrity of instant price quotes almost immediately begins to go haywire. Traders have even stricter requirements, as the prices and trades can change in an instant resulting in big variances between quotes. This increased volatility can have a profound impact on execution prices and ability to fill orders.
When an investor places a large order, such as for 10,000 shares, they may not receive the entire order at a single price point. Rather, it allows it to be done in bite-sized chunks. For example, one order might be executed with two tranches of 5,000 shares. Now multiply that by the high octane, turbocharged, hyper-competition climate of NASDAQ with over 500 Market Makers competing against each other, this situation is the norm.
The difference between these quoted prices and the actual execution price is most apparent in quick moving markets. In a fast-moving market, an order that should fill at a certain price might get filled at multiple prices. This is largely due to how quickly market conditions shift. Fills happen at many different prices and quantities. This unfortunate occurrence signifies the very real dangers of participating in markets during times of extreme volatility.
Understanding Market Dynamics
This competitive spirit is only cultivated and made possible by the structure of NASDAQ, which includes more than 500 Market Makers. Furthermore, these firms play an important role providing liquidity to the market. Their existence makes it necessary for traders to contend with a convoluted maze of pricing structures. In a fast market, the state of the market at the time an order is received may differ significantly from real-time quotes.
In reality, market participants all too frequently get caught on the wrong side of rampant price swings. For example, an order for 10,000 shares may be filled in various portions—2,500 shares might execute at one price point while 7,500 shares execute at another. This lack of coordination increases the risk of unintended trading results that are far different from intended or anticipated outcomes.
These transactions are conducted within milliseconds. As a result, brokers tend to set up high margin maintenance requirements on individual stocks. Excessive volatility is particularly prevalent among stocks in the Internet, e-commerce, and other high-tech sectors. Consequently, they can demand an up-front and ongoing margin of 60-70%. This added caution is due to the fact that trading in these assets is much riskier than trading in other assets.
Orders and Execution Strategies
In equity markets trading, the order type used has tremendous influence on execution quality results. A market order is executed on a first-come, first-served basis. Thus, if orders precede a trader’s submission, those will take priority. This new system can make trading even more difficult in today’s fast market where prices are always on the move.
Stop orders and stop limit orders have notable differences that traders need to be aware of. A stop limit order allows traders to set a price limit for order execution. By comparison, a stop order has no price limit at all, executing automatically once it reaches an expected sell or buy price. In times of high volatility, these trades can execute at prices above or below the specified stop price. This growing reality highlights the need for thoughtful, strategic planning.
Investors serious about minimizing their risk need to be alert to margin requirements. Make sure to contact your brokerage to get information tailored specifically to them! As mentioned above, customers can call 1-800-TRADERS to find out if specific stocks have increased margin maintenance requirements.
“$2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales.” – Regulation T of the Federal Reserve Board
Implications for Traders
The consequences of trading in an ultra-high-speed environment go far beyond just execution differences. Now more than ever, investors need to stay awake at the wheel and adjust their approaches to consider the potential for extreme price swings. With the possibility of orders being filled at different prices, the need for real-time assessment of the market becomes even more critical.
Investors and traders should always be cognizant of the margin requirements that come with their level of investment. Increased standards for volatile equities mean more precise financial strategizing to avoid losses due to unpredictable market activity.