The NYSE Introduces New Rules That Will Disadvantage Small Investors
Summary NYSE is removing stop loss orders and good-till-canceled orders. The stop loss orders were significantly less useful for casual investors, but did provide some excellent opportunities for buying at discounts in illiquid stocks. The removal of good-till-canceled orders is a terrible change that reduces market liquidity by pushing out retail investors. There is a way to mitigate at least part of the impact by arranging conditional orders to trigger a “good-till-date” after the desired price is reached. Investors should use a great deal of caution when learning about using new order types to get around this problem. For investors who haven’t heard, the NYSE released an update to tell traders and investors that they would be eliminating two types of orders. Bloomberg focused on the “stop loss” orders , but the bigger change may be regarding the “good-till-canceled” order. Chris Demuth Jr. had an article out recently that covered some of the changes. I don’t read much of what comes out on Bloomberg , but I do browse through the works of Mr. Demuth Jr. and I appreciated his take on it. I’d like to share my take on the investing implications of each change. No Stop Loss Orders While I’m not a fan of removing tools from the hands of smaller investors, I can understand the exchange wanting to remove stop loss orders. They are used very infrequently, and may contribute to absurd price movements. I’ve often warned readers that I consider stop loss orders to be a terrible way to design a portfolio for failure in the mREIT space. Some of my most successful ideas have been designed specifically to take advantage of market failures, where a sell-off by one group of investors would trigger prices to drop low enough to trigger the stop loss orders. For instance, I predicted that the major news reporting sites would declare a huge miss on earnings for Orchid Island Capital (NYSE: ORC ), because analysts were forecasting “Core EPS” and the company only reported “GAAP EPS”. The extremely different calculations were going to result in the news stations reporting “a huge miss”, when there was no such miss. That was a great trade opportunity for investors. The stop loss orders were a great source of profits in the mREIT sector, because prices tend to drop significantly on the ex-dividend date. Even if the investor had their order designed to be adjusted for dividends, a little irrationality among other players could trigger the price to fall far enough to trigger those orders. When it comes to protecting traders from themselves, removing stop loss orders may actually be a good thing. On the other hand, the stop loss orders may also be used by traders that were shorting a security and wanted to exit their short position if something happened that suddenly drove prices higher. In this case, removing the stop loss does little to help investors, because any investor involved in shorting should be competent enough to know the risks and design their strategy accordingly. Implications Removing stop loss orders should result in less total volatility for traders and investors. Less volatility means lower risk premiums, and therefore, higher fair values, assuming investors maintained the same risk tolerance as before. This should be good for the market overall, but it remains a sad day for me as an investor, because finding an opportunity where stop loss orders would be triggered by an irrational price movement was a great strategy for finding good investments at bargain prices. No Good-Till-Canceled Orders Neither the update from NYSE nor the one from Bloomberg were thorough in defining which good-till-canceled orders would be removed. Were these orders indefinite, or were they orders that would be good for 30-60 days unless canceled? Personally, I find this change to be absolutely absurd. This hurts retail investors in a bad way, and it helps large investors. Allow me to explain how I can get around this rule. If I’m no longer allowed to place a “good-till-canceled” order, I’m still capable of placing a conditional command to enter a new limit order to buy shares if a certain condition, such as a price, is reached. The old order would’ve looked like this: “I want to buy shares of the Schwab U.S. REIT ETF (NYSEARCA: SCHH ) at any time in the next 60 days if those shares can be purchased for $35.00 or less.” The new order would look like this: ” If shares of the Schwab U.S. REIT ETF fall below $35.00, enter a new order for the day that I would like to buy shares if they can be purchased for $35.00 or less”. The only difference in these orders is the amount of work to create the order, and how frequently I might need to reset the orders. I had never bothered using the new order type, because the old order was so simple. For any investor who might be confused with the second order type, this is known as a “good-till-date” order, and there was no reference to the NYSE removing “good-till-date” orders. Since this new system would only enter the order after the price of $35.00 was seen, it would have a fairly solid opportunity for the order to execute. I Loved Good-Till-Canceled A substantial portion of my investment portfolio (excluding mutual funds in employer sponsored accounts) was purchased using this order type. I will admit that in one scenario, I forgot I had left one of these orders open and got a surprise e-mail indicating that my order had finally been triggered several weeks later. No problem, I keep enough cash on hand to cover such orders, and had 3 days to get the funds into my account to cover my purchase. My Favorite Good-Till-Canceled Order The date I got those “surprise” e-mails telling me I had some orders triggered was August 24th. Many investors may remember the date for the very short-term price fluctuation that triggered the NYSE to introduce these changes. On that day, I picked up shares of SCHH at $37.52 and shares of the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) at $34.59. I’m up quite nicely on both positions. Implications Removing this order type should have the exact opposite impact of what the NYSE claims to want. Those good-till-canceled orders encouraged prices to be more efficient, because they allowed buyers who were aware of the risks to effectively leave someone standing in line to buy up any shares that people wanted to sell at a given price. It requires significantly more selling pressure for prices to fall rapidly when numerous investors have left an order that they would be happy to buy at a certain price. Without the good-till-canceled orders to buy up shares of those ETFs, the crash on August 24th could have been substantially worse. The bigger issue here, in my opinion, is that this creates an unfair competitive advantage for the larger players. Many retail investors may not have access to the tools to place the “new order”, but the large traders have had these tools for a long time and have vastly more complicated models to execute them. The gap between the tools available to normal investors and the tools available to large investors will increase, while the liquidity available in the market will decrease. A reduction in liquidity would increase the volatility of price swings and work in precisely the opposite manner of removing the “stop loss” orders. In this case, the increased volatility would encourage lower fair values, assuming the same risk profile for the investor. Clearing Orders One major reason that the good-till-canceled order was so important is the presence of hard selling or buying activity when the market opens. If investors all swap to using conditional orders to create an order to buy a security, then those orders won’t be on the NYSE’s books. Hard selling could result in the opening price being very low, triggering several new “good-till-date” orders to be introduced to buy the security, and the price immediately popping back up. Every investor who was trying to sell at the moment trading opened would have lost out, because many people desiring to buy at those prices would have been excluded from having their order active until the initial price had been recorded. I may need to look into those conditional orders and see if I can create one that simply checks the date, and if it is before a certain date enters a new “good-till-date” limit order. That would be nice for allowing me to have the order in place before the market opens each day. Unfortunately, each investor wanting this option would need to speak with their brokerage and determine if it is available for their account types, and if they would be permitted to use it. Even if their brokerage offers it, investors should be very careful to ensure they know precisely what they are doing before they experiment with new order types.