This is a follow-up post to “Are stock prices random? A look at market structure“. Here is a list of some order execution traps.
I would never use them. In the past, there have been numerous shenanigans that took advantage of market orders. In Warren Buffett’s day, a brokerage firm would delay execution on a market order until it could find a matching buy and sell order. Then the buy order would get filled at the ask price and the sell order at the buy price. This allowed the brokerage firm to make a risk-free profit. Nowadays, the abuses are of a smaller magnitude but they still exist.
Even Jim Cramer will tell you not to do it.
All or none orders
Banned in Canada for a reason.
Retail brokerages that sell your order flow to other companies
Interactive Brokers tends to have better execution than other retail brokerages because it doesn’t play these games. In my experience, Etrade is the worst. They exploit exceptions and loopholes to the NBBO rules (this gets into really obscure stuff). The simple answer is that the financial markets aren’t that honest. Trading costs have gotten a lot better but there are still problems with sub-penny front running / price improvement, internalization of orders, etc. etc.
Some brokerages will trade against you. For example, TD Waterhouse trade confirmations will state if TD’s market making arm is on the other side of your trade. There are many conflicts of interest that can happen if a brokerage firm is trading against its own clients. Many market makers don’t want anything to do with small illiquid stocks (for risk management reasons). Retail investors may get good order execution since their order won’t interact with their brokerage’s market making arm.
Many major investment banks own a part of stock exchanges and have market making operations. They are trading against their customers.
I learned the hard way not to trade these. High-speed computers will pick off your slow quotes. When the market for the common stock has a sudden price gap, there are low-risk (or no-risk) arbitrage opportunities for fast computers to arbitrage the common stock’s bid/ask versus the options markets’ bid/ask.
In the aftermath of the flash crash, orders that were beyond the 30% band of the opening price of a stock were cancelled. I believe that this move unfairly benefits the exchanges’ biggest customers: market makers, high-frequency traders, and other financial parasites. In my opinion, this is extremely unfair to the exchange’s legitimate customers. Because of this, I see no reason to use extreme limit orders or to provide liquidity in event of a flash crash. There is no point in taking risk and having exchanges take away any profits.
I’ve had a filled order in the penny stock NXTH that was cancelled for reasons unknown to me. So I just don’t see how financial markets are transparent or fair to its real customers. Without investors the exchanges would not be able to make money. Market makers and high-frequency traders do not generate value.
I think that investors should be wary of frequent trading. By trading less, they minimize the hidden costs of their trading. I would try to do as little business as possible with companies that skim money from its customers.