Fast Markets

[stockwc exchange=”NASDAQ” symbol=”^BSESN”]

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:

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.

Why Watch Market Indicators?

A common and effective way to gain perspective on stock price fluctuations is to compare the movement of your stocks to that of indices or market indicators. About 100 years ago, as the number of individual stocks grew, the need to measure how the stock market performed became obvious. In 1896 The Dow Jones Company took groups of stocks and averaged their prices to create the first indices, the Dow Jones Averages. They created four different indices: one for industrial companies, one for utilities, one for transportation companies and a composite that included the three other indices.

In the 1920s, Standard & Poor’s Corporation (S&P) created separate indices. These indices also measured the market as a whole in addition to some sectors of the market. In 1957, when technology enabled the companies to start calculating their indices on an hourly basis, S&P created the S&P 500 Index, which measured the performance of a larger proportion of the market compared to the more popular Dow Jones Industrial Index.

Over the years, the S&P and Dow Jones indices have remained popular, leading both companies to create other indices. In addition, other companies and even the exchanges themselves have created more indices.

Different indices are calculated in different ways. Few remain as simple averages. An index moves when the stocks in it move. When a stock in an index goes up or down, so does the index. Hence, when you hear that the Dow Jones closed at 10,500, down 20 points for the day, it means that the average of the prices of the 30 stocks that comprise the Dow is 10,500 and the combined value of these 30 stocks (as calculated by the index) dropped 20 points during that day’s trading.

Calculation method aside, all indices measure the performance of the stock market or some subsection of it on a continuing basis throughout each trading day. By tracking an index, or a variety of indices, investors can quickly gauge market trends that may impact investment decisions.

What is the point of following the indices when what you care about is your own stock portfolio performance?

Indices often reflect trends in the market and in the economy. Watching overall market performance can be the key to making smart decisions about your individual investments. For example:

  • Indices can function as benchmarks to compare the performance of the stocks you own against the market in general.
  • Comparing today’s market movement with similar market movements from the past may help you become aware of trends, and the best times to buy or sell.

You may want to create an index of your own stocks so you can measure your own investments against the performance of the more established indices. As an illustration of how to do this we have created the following hypothetical index

Stock 12/17 Close 12/18 Close 12/19 Close
ABC 52 51 52
DEF 25-1/2 23 ¾ 25
GHI 49 46 47-1/2
JKL 15 15 ¼ 15-1/2
Total 141.5 136 140
Average 35.375 34 35
Percent Move -4% 3%

Now, you can compare the movement of your index to some of the big market indicators, like the S&P 500, the Dow Jones Industrial Average (DJIA) or the Nasdaq.

There are a couple of ideas to keep in mind when analyzing indices. First, the percentage move is often more meaningful than the move in points. It means a lot more when the DJIA moves 50 points if it is at 1,000 than if it is at 10,000. Second, while individual stock prices, at least for the time being, are generally expressed as fractions, indices are displayed in decimals.

Dow Jones Industrial Average

One of the best-known market indicators, the Dow Jones Industrial Average, is comprised of 30 leading companies. Calculated by adding the prices of these 30 stocks, the Dow is now considered a figure that indicates the general state of the market. Originally, the Dow divided the sum of the prices of the 30 stocks by 30, giving a true average. However, to be consistent every time a stock split or paid a dividend, the number 30 had to be adjusted. Now, over 100 years later, the sum of the prices of the 30 stocks is divided by a number less than one! Since a $1 movement in the price of a $100 stock counts equally with a $1 movement in the price of a $20 stock, the Dow Jones is considered a price weighted index.

Charles Dow designed the average to represent the current business market, which in 1896 included industries such as sugar, leather, tobacco, gas, rubber and coal. Today the DJIA is led by retailers, oil, technology, pharmaceutical and entertainment companies. The only company on the original list that is still included today is General Electric.

S & P 500 Index

Created in the 1920s by the Standard and Poor’s Corporation (S & P), this index tracks 500 companies in leading industries: transportation, utilities, financial services, technology, health care, energy, communications, services, capital goods, basic materials, consumer products, cyclicals and more. Many consider it the most accurate reflection of the U.S. stock market today. This high regard has led many money managers and pension plan administrators to use it as a benchmark for judging the overall performance of their fund against the stock market.

Since the calculation for this index equals the price of each stock multiplied by the number of shares held by the public, the companies with the most shares make the greatest impact. This is known as a market weighted index.

Dow Jones Chart 9/13/1999 13:37
Last: 11,033.49
Change: 5.06
Open: 11,027.40
High: 11,042.36
Low: 10,982.20
Volume: 35,816,500
Percent Change: 0.05%
Yield: 1.58%
P/E Ratio: 27.99
52 Week Range: 7,399.38 to 11,428.94

Nasdaq Index

This index tracks the stocks on the National Association of Securities Dealers Automated Quotation System (Nasdaq) stock market. Since many new companies elect to join the Nasdaq, the number of stocks on the Nasdaq has grown from 100 to more than 5,500 today. Because this index includes many companies in the technology sector where market trends change quickly, this index can be volatile.

Ameritrade Online Investor Index

The Ameritrade Online Investor Index tracks the daily buying and selling activity of individual online investors at Ameritrade, Inc.

While most major market indices include the activity of institutions and mutual fund companies, the Online Investor Index is unique in that it helps you understand what individual investors are doing in relation to the stock market.

The Online Investor Index does not measure price changes or volume-other indices do that. Instead, the Index measures buyer participation as a behavioral indicator related to investor confidence.

To learn more about the Ameritrade Online Investor Index, visit our website at www.ameritradeindex.com.

< < Previous