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A New York Stock Exchange (NYSE) Trader Update dated Nov. 16, 2015, abruptly announced:
Subject to effectiveness of a rule filing with the SEC, NYSE and NYSE MKT will no longer accept new Stop Orders and Good Till Cancelled (“GTC”) Orders beginning February 26, 2016. Additionally, all existing GTC and Stop Orders residing on the NYSE book will be cancelled.
The NYSE ending GTC orders – which typically expire in 90 days anyway – isn’t a big deal because brokerages have their own in-house GTC orders investors can still employ.
And brokerages will still offer stop-loss orders. The only difference will be they’ll get triggered in-house and then sent as a limit or market order to be executed.
Since investors can still place stop orders and GTC orders with brokerages, the NYSE saying it will no longer accept them doesn’t appear to be earth-shattering.
But It Is. Let Me Tell You Why…
The only explanation for the Exchange’s rule change came from an unnamed NYSE spokeswoman whose email response to inquiries was:
Many retail investors use stop orders as a potential method of protection, but don’t fully understand the risk profile associated with the order type. We expect our elimination of stop orders will help raise awareness around the potential risks during volatile trading.
What the NYSE (which is regulated by the U.S. Securities and Exchange Commission and has to have all its rules approved by the SEC) isn’t saying is that with the approval of their regulator, they’re ending two order types investors have used on the Exchange to limit their losses for over 100 years.
And they’re doing it because the public face of trading, the venerable New York Stock Exchange, the stock market as we know it, is broken and they don’t want to take responsibility for what has happened and what is going to happen.
In other words, because the SEC has lost control of stock market trading on the venues it regulates, it is passing responsibility for investor losses along to brokerage houses and, ultimately, to individual investors themselves.
Stop-loss orders are mostly used by investors who aren’t able or willing to watch the market all the time. By putting down a stop order, an investor could “stop the loss” on a position if the price of his stock fell to a predetermined level.
A stop order becomes a “market” order when the stop-loss price is reached.
For example, if you own a stock at $50 and want to sell it by using a stop order if it falls to $45 (for a 10% loss), once the stock trades at $45, your stop order becomes a “market” order and your stock is sold at the next best price someone is willing to pay. You may sell stock at $45, or less, depending on where other buyers are bidding for your stock.
There used to be lots of “standing” orders left with NYSE specialists and Nasdaqmarket-makers, so when a stop order was triggered, the seller could usually sell his stock at or just below where his stop order became a market order.
When there were lots of standing orders waiting to buy and sell shares, individual stocks and the market didn’t have the huge swings like they have today.
Buy orders could always get cancelled, and a stock or the market could fall steeply. But buyers and sellers typically lined up to transact at prices considered fair and orderly.
That’s all changed.
How Bad Management Thins Market Liquidity
The United States has 14 stock exchanges and dozens of “dark pools.” And because competing trading venues need orders to create transactions, they “pay for order flow” from brokerage houses and institutional money managers. All that competition spreads orders far and wide. So there’s no singular exchange or place where hundreds or thousands of “standing” orders reside waiting to be executed.
By not properly managing competing trading venues and allowing unrestrained selling of order flow, the SEC aided and abetted the “thinning of liquidity.”
The minimum increment a stock can be traded in has also changed.
Up until 2001, stocks mostly traded in increments of an eighth of a dollar, or $0.125. Now, under “decimalization,” stocks trade in increments as small as a penny.
What seemed like a good idea to narrow spreads – the difference between the price someone is willing to pay for a stock and the price someone is willing to sell that stock for (which used to be $0.125 and can now be $0.01) – turned out to be another nail in the market’s coffin.
While decimalization theoretically reduced spreads and transaction costs, in practice what happened is investors didn’t leave their orders standing around because intermediaries (meaning specialists on the NYSE and Nasdaq market-makers) could take a small one-penny-per-share risk and buy stock a penny ahead of a standing order they saw residing on their books.
By not correcting the mistake of moving to decimalization, the SEC allowed short-term traders to front-run standing orders and use those standing orders as a backstop to exit their trades if prices went the wrong way. That unfair treatment caused investors to leave fewer standing orders in the market, which aided and abetted the “thinning of liquidity.”
Of course, the NYSE can’t say any of that.
All they can say is they won’t accept stop orders.
They should say it’s because market liquidity is so thin on big down days, thanks to what the SEC has allowed, that stop orders will get filled way below where they should.
And the NYSE and the SEC now want you to blame your brokerage house for that, or blame yourself for not being more aware of the risks inherent in stop orders.
How to Protect Your Profits Now
My advice is to keep using your stop-loss orders as long as your brokerage lets you because using stop orders is smart.
Every empirical study ever done on using stop-loss orders and trailing stops demonstrates they can be incorporated in portfolio management to meaningfully enhance returns.
Just be aware: Because of what the SEC allows to happen on their watch, you will get bad fills on your stop orders, and you will get stopped out and watch your stock pop right back to some higher level after you’ve been screwed out of your position.
If you choose not to use stop orders, you need to watch the market and your stocks. You can do that by setting up “alerts” on your smartphone or computer to alert you when your positions hit a predetermined price.
And if you keep losing money because the market becomes increasingly volatile, or you’re on the sidelines not making any money because you’re afraid of what’s become of the stock market, send a letter to the SEC and tell them to fire themselves.
They really deserve it.
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Stop Orders will still exist. It will now be done by Computers instead of Specialists who are the overseers of the dual transaction of Buy/Sell. It’s a Good thing the Specialists are out of the picture now.