Order types and price protection

A stop order is dormant until the stop price trades. Then it becomes a market order. Because it is placed to limit a loss, it sits on the “wrong” side of the market: a sell stop below the current price protects a long position; a buy stop above the current price protects a short position.

A stop-limit order also waits for the stop price, but then becomes a limit order. It protects price but may never fill if the market gaps through the limit.

Two details from the SEC’s own description of these orders are easy to miss and often tested. The first is the default: unless the customer specifies otherwise, the broker will enter the order as a market order — so an instruction that names no order type is a market order, with all that follows about certainty of execution and uncertainty of price. The second is that a stop order is not a promise about price at any stage. It waits for the stop price to be reached, at which point it becomes a market order; a short-term fluctuation can be enough to activate it, and the price at which the trade is then executed may differ from the stop price, especially in a fast-moving market. A stop protects against not selling, never against selling badly.

Every order also has a duration. Unless the investor specifies a time frame, an order is a day order: it is good only during that trading day, and if it does not execute during regular trading hours it expires. It does not carry over into after-hours trading or into the next trading day. A good-til-canceled order, or GTC, lasts until it is filled or canceled, although brokerage firms typically limit how long a GTC order can stay open, and that limit varies from firm to firm.

The distinction is not bookkeeping. Regulation Best Interest applies when a recommendation of a securities transaction or investment strategy is made to a retail customer, and the obligations that follow — disclosure, care, conflicts, compliance — hang on that recommendation having been made. An order nobody recommended does not carry them. This is why the marking matters, and also why it cannot be used as a lever: the marking records which happened, and the obligation follows the fact rather than the label. A representative who recommends a stock and then marks the ticket unsolicited has not escaped anything; they have made a false record of a recommendation they still made.

The record itself is prescribed. A memorandum of every brokerage order and of any other instruction must be made, whether the order was executed or not, and it must show the terms and conditions of the order and of any modification or cancellation, the account for which it was entered, the time it was received, the time of entry, the price at which it was executed, and the associated person responsible for the account. One category is singled out: an order entered pursuant to the exercise of discretionary authority must be so designated.

That gives three categories worth keeping apart. Unsolicited: the customer chose. Solicited: the firm recommended and the customer chose. Discretionary: the firm chose, which it may only do where the customer has given prior written authority to a named individual and the firm has accepted the account in writing.