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The Investment FAQ (part 19 of 20)

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Archive-name: investment-faq/general/part19
Version: $Id: part19,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott

See reader questions & answers on this topic! - Help others by sharing your knowledge
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance.  This is a plain-text
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for any inaccuracy, error or omission, regardless of cause, in The
Investment FAQ or for any damages (whether direct or indirect,
consequential, punitive or exemplary) resulting therefrom.  

Rules, regulations, laws, conditions, rates, and such information
discussed in this FAQ all change quite rapidly.  Information given
here was current at the time of writing but is almost guaranteed to be
out of date by the time you read it.  Mention of a product does not
constitute an endorsement. Answers to questions sometimes rely on
information given in other answers.  Readers outside the USA can reach
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Call USA.  All prices are listed in US dollars unless otherwise
Please send comments and new submissions to the compiler.

--------------------Check for updates------------------

Subject: Trading - Order Routing and Payment for Order Flow

Last-Revised: 25 Nov 1999
Contributed-By: Bill Rini (bill at, Terence Bergh, Chris
Lott ( contact me ), W.  Felder

A common practice among brokerage firms is to route orders to certain
market makers.  These market makers then "rebate" 1 to 4 cents per share
back to the brokerage firm in exchange for the flow of orders.  These
payments are known as "payment for order flow" (PFOF).  (The account
executive does not receive this compensation.) Order routing and PFOF
occurs in stocks traded on the NYSE, AMEX and NASDAQ.  NYSE and AMEX
stocks traded away from the exchange are said to be traded "Third

Payment for order flow has been a mechanism that for many years has
allowed firms to centralize their customers' orders and have another
firm execute them.  This allowed for smaller firms to use the economies
of scale of larger firms.  Rather than staffing up to handle 1,000,
5,000 or so orders a day, a firm can send it's 1,000 or 5,000 orders to
another firm that will combine this with other firm's orders and in turn
provide a quality execution which most of the time is automated and is
very broad in nature.  Orders are generally routed by computer to the
receiving firm by the sending firm so there is little manual
intervention with orders.  This automation is an important part of this
issue.  Most small firms cannot handle the execution of 3,000 or more
different issues with automation, so they send their orders to those
firms that can. 

For example, Firm A can send it's retail agency orders to a NASDAQ
market maker or Third Market dealer (in the case of listed securities)
and not have to have maintain day-in and day-out the infrastructure to
"handle" their orders.  In return for this steady stream of retail order
the receiving firm will compensate Firm A for it's relationship.  This
compensation will generally come in the form of payment per share.  In
the NASDAQ issues this is generally 2 cents, while in NYSE issues its 1
cent per share.  Different firms have different arrangements, so what I
have offered is just a rule of thumb. 

These "rebates" are the lifeblood of the deep discount brokerage
business.  Discount brokerage firms can afford to charge commissions
that barely cover the fixed cost of the trade because of the payments
they receive for routing orders.  But understand that payment for order
flow is not limited to discounters, many firms with all types of MO's
use payment for order flow to enhance their revenues while keeping their
costs under control.  Also understand that if you require your discount
broker to execute your orders on the NYSE (in the case of listed
securities), you will find that the broker you are using will eventually
ask you to pay more in commissions. 

Firms that pay for order flow provide a very important function in our
marketplace today.  Without these firms, there would be less liquidity
in lower tier issues and in the case of the Third Market Dealers, they
provide an alternative to a very expensive primary market place i.e. 
NYSE and ASE.  For example if you take a look at Benard Madoff (MADF)
and learn what their execution criteria is for the 500 to 600 listed
issue that they make a market in, you would be hard pressed to find ANY
difference between a MADF execution and one executed on the NYSE.  In
some cases it will even be superior.  There are many Third Market Firms
that provide quality execution services to the brokerage community, DE
Shaw, Trimark are two others that do a great job in this field. 
However, please realize that the third market community would have a
hard time existing without the quote, size and prints displayed by the
primary exchanges. 

The firm that receives payment for its order flow must disclose this
fact to you.  It is generally disclosed on the back of your customer
confirmation and regularly on the back of your monthly statement.  This
disclosure will not identify the exact amount (as it will vary depending
on the order involved, affected by variables such as the market, limit,
NMS, spread, etc.), but you can contact your broker and ask how much was
received for your order if in fact payment was received for your order. 
You will probably get a very confused response from a retail broker
because this matter (the exact amount i.e., 2 cents or 1.5 cents ) will
generally not be disclosed to your individual broker by the firm he/she
is employed by. 

It is hard to "tell" if your order has been subject to payment.  Look
closely at your confirmation.  For example if the indicated market is
NYSE or ASE then you can be rest assured that no other payment was
received by your firm.  If the market is something like "other" coupled
with a payment disclosure, your order may in fact be subject to payment. 

There are two schools of thought about the quality of execution that the
customer receives when his/her order is routed.  The phrase "quality of
execution" means how close was your fill price to the difference between
the bid/ask on the open market.  Those who feel that order routing is
not detrimental argue that on the NASDAQ, the market maker is required
to execute at the best posted bid/ask or better.  Further, they argue,
many market making firms such as Mayer Schweitzer (a division of Charles
Schwab) execute a surprising number of trades at prices between the
bid/ask.  Others claim that rebates and conflict of interest sometimes
have a markedly detrimental affect on the fill price.  For a lengthy
discussion of these hazards, read on. 

To realize the lowest overall cost of trading at a brokerage firm, you
must thoroughly research these three categories:
  1. The broker's schedule of fees. 
  2. Where your orders are directed. 
  3. If your NYSE orders are filled by a 19c-3 trading desk. 

Category 1 includes "hidden" fees that are the easiest costs to
discover.  Say a discount broker advertises a flat rate of $29.00 to
trade up to 5,000 shares of any OTC/NASDAQ stock.  If the broker adds a
postage and handling fee of $4.00 for each transaction it boosts the
flat rate to $33.00 (14% higher).  Uncovering other fees that could have
an adverse impact on your ongoing trading expenses requires a little
more digging.  By comparing your broker's current fees (if any) for
sending out certificates, accepting odd-lot orders or certain types of
orders (such as stops, limits, good-until-canceled, fill-or-kill,
all-or-none) to other brokers' schedules of fees, you'll learn if you're
being charged for services you may not have to pay for elsewhere. 

Category 2 is often overlooked.  Many investors, especially those who
are newer to the market, are not aware of the price disparities that
sometimes exist between the prices of listed stocks traded on the
primary exchanges (such as the NYSE or AMEX), and the so-called "third
marketplace." The third marketplace is defined as listed stocks that are
traded off the primary exchanges.  More than six recent university
studies have concluded that trades on the primary exchanges can
sometimes be executed at a better price than comparable trades done on
the third market. 

Although there is nothing intrinsically wrong with the third market, it
may not be in your best interest for a broker to route all listed orders
to that marketplace.  If you can make or save an extra eighth of a point
on a trade by going to the primary exchange, that's where your order
should be directed.  After all, an eighth of a point is $125.00 for each
1,000 shares traded. 

Here's how the third market can work against you: Say you decide to
purchase 2,000 shares of a stock listed on the NYSE.  The stock
currently has a spread of 21 to 21 1/4.  Your order, automatically
routed away from the NYSE to the third market, is executed at 21 1/4. 
Yet at the NYSE you could have gone in-between the bid-ask and gotten
filled at 21 1/8, a savings of $250.00. 

Only a few of the existing deep discount brokers will route your listed
stock orders to the primary exchanges.  Most won't as a matter of
business practice even if asked to do so.  The only way to be sure that
your listed stock orders are being filled on the primary exchanges is to
carefully scrutinize your confirmations.  If your confirmation does not
state your listed order was filled on the NYSE or AMEX then it was
executed on the third market. 

You run the greatest risk of receiving a bad fill -- or sometimes
missing an opportunity completely -- whenever you trade any of the
stocks added to the NYSE since April 26, 1979, and your trade is routed
away from the primary exchange onto the third market.  Almost all AMEX
stocks run this risk. 

Category 3 was understood only by the most sophisticated of investors
until recently.  A 19c-3 trading desk is a (completely legal) method of
filling NYSE orders in-house, without exposing the orders to the public
marketplace at all.  Yes, you'll get your orders filled, but not
necessarily at the best prices.  NYSE stocks listed after April 26,
1979, sector funds (primarily "country" funds such as the Germany Fund
or Brazil Fund), and publicly-traded bond funds are the securities
traded at these in-house desks.  Recently, the NYSE approached the
Securities Exchange Commission asking that Rule 19c-3, that allows this
trading practice, be repealed.  Edward Kwalwasser, the NYSE's regulatory
group executive vice president stated flatly that, "The rule hasn't done
what the Commission thought it would do.  In fact, it has become a
disadvantage for the customer."

Here's a scenario that helps explain the furor that has developed over
the 19c-3 wrinkle.  Let's say that XYZ stock is trading with a spread of
9 1/2 to 9 3/4 per share on the floor of the NYSE.  An investor places
an order to buy the stock and the broker routes that order away from the
NYSE to the internal 19c-3 desk.  The problem emerges when the order
reaches this desk, namely that the order is not necessarily filled at
the best price.  The desk may immediately fill it from inventory at 9
3/4 without even attempting to buy it at 9 5/8 for the customer's
benefit -- this is the spread's midpoint on the floor of the exchange. 
Then, after filling the customer's order internally, the firm's trader
may then turn around and buy the stock on the exchange, pocketing the
extra 12 1/2 cents per share for the firm.  Project this over millions
of shares per year and you can get an idea of the extra profits some
brokers are squeezing out at the expense of their trusting, but
ignorant, customers. 

You can most likely resolve this dilemma between low commissions and
quality of execution by examining the volume of trades you do.  If you
buy a few shares of AT&T once a year for your children, then the
difference in fees between a trade done by a discount broker as compared
to a full-service wire house will most likely dominate an 1/8 or even a
1/4 improvement in the fill price.  However, if you work for Fidelity
(why are you reading this?) and regularly trade large amounts, then you
certainly have negotiated nicely reduced commissions for yourself and
care deeply about getting a good fill price. 

Finally, the whole issue may become much less important soon.  Under the
new rules for handling limit orders on the NASDAQ market, payment for
order flow is becoming more and more burdensome on execution firms. 
With the advent of day trading, specialty firms that use the NASDAQ's
SOES execution system, along with other systems to "game" the market
makers, the ability of firms to pay others for their orders is becoming
increasingly difficult.  This "gaming" of the market place is due to
different trading rules for different market participants (this issue by
itself can take hours to explain and has many different viewpoints). 
Many firms have discontinued paying for limit orders as they have become
increasingly less profitable than market orders. 

As of November 1999, the Wall Street Journal that payment for order flow
is a practice that is dying out fairly rapidly. 

Note: portions of this article are copyright (c) 1996 by Terrence Bergh,
and are taken from an article that originally appeared in Personal
Investing News, March 1995. 

--------------------Check for updates------------------

Subject: Trading - Day, GTC, Limit, and Stop-Loss Orders

Last-Revised: 5 May 1997
Contributed-By: Art Kamlet (artkamlet at

Day/GTC orders, limit orders, and stop-loss orders are three different
types of orders you can place in the financial markets.  This article
concentrates on stocks.  Each type of order has its own purpose and can
be combined. 

   * Day and GTC orders:
     An order is canceled either when it is executed or at the end of a
     specific time period.  A day order is canceled if it is not
     executed before the close of business on the same day it was
     placed.  You can also leave the specific time period open when you
     place an order.  This type of order is called a GTC order (good
     'til cancelled) and has no set expiration date. 
   * Limit orders:
     Limit orders are placed to guarantee you will not sell a stock for
     less than the limit price, or buy for more than the limit price,
     provided that your order is executed.  Of course, you might never
     buy or sell, but if you do, you are guaranteed that price or
     For example, if you want to buy XYZ if it drops down to $30, you
     can place a limit buy @ $30.  If the price falls to $30 the broker
     will attempt to buy it for $30.  If it goes up immediately
     afterwards you might miss out.  Similarly you might want to sell
     your stock if it goes up to $40, so you place a limit sell @ $40. 
   * Stop-loss orders:
     A stop-loss order, as the name suggests, is designed to stop a
     loss.  If you bought a stock and worry about it falling too low,
     you might place a stop-loss sell order at $20 to sell that stock
     when the price hits $20.  If the next trade after it hits $20 is 19
     1/2, then you would sell at 19 1/2.  In effect the stop loss sell
     turns into a market order as soon as the exchange price hits that
     Note that the NASDAQ does not officially accept stop loss orders
     since each market maker sets his own prices.  Which of the several
     market makers would get to apply the stop loss? However, many
     brokers will simulate stop-loss orders on their own internal
     systems, often in conjunction with their own market makers.  Their
     internal computers follow one or perhaps several market makers and
     if one of them quotes a bid which trips the simulated stop order,
     the broker will enter a real order (perhaps with a limit - NASDAQ
     does recognize limits) with that market maker.  Of course by that
     time the price might have fallen, and if there was a limit it might
     not get filled.  All these simulated stop orders are doing is
     pretending they are entering real stops (these are not official
     stop loss orders in the sense that a stock exchange stop order is),
     and some brokers who work for the firms that offer this service
     might not even understand the simulation issue. 
     If you sell a stock short, you can protect yourself against losses
     if the price goes too high using a stop-loss order.  In that case
     you might place a stop-loss buy order on the short position, which
     turns into a market order when the price goes up to that figure. 


Let's combine a stop loss with a limit sell and a day order. 

XYZ - Stop-Loss Sell Limit @ 30 - Day Order Only

The day order part is simple -- the order expires at the end of the day. 

The stop-loss sell portion by itself would convert to a sell at market
if the price drops down to $30.  But since it is a stop-loss sell limit
order, it converts to a limit order @ $30 if the price drops to $30. 

It is possible the price drops to 29 1/2 and doesn't come back to $30
and so you never do sell the stock. 

Note the difference between a limit sell @ $30 and a stop-loss sell
limit @ $30 -- the first will sell at market if the price is anywhere
above $30.  The second will not convert to a sell order (a limit order
in this case) until the price drops to $30. 

You can also work these same combinations for short sales and for
covering losses of short stock.  Note that if you want to use limit
orders for the purpose of selling stock short, there is an exchange
uptick rule that says you cannot short a stock while it is falling - you
have to wait until the next uptick to sell.  This is designed to prevent
traders from forcing the price down too quickly. 

--------------------Check for updates------------------

Subject: Trading - Pink Sheet Stocks

Last-Revised: 2 Sep 1999
Contributed-By: Art Kamlet (artkamlet at

A company whose shares are traded on the so-called "pink sheets" is
commonly one that does not meet the minimal criteria for capitalization
and number of shareholders that are required by the NASDAQ and OTC and
most exchanges to be listed there.  The "pink sheet" designation is a
holdover from the days when the quotes for these stocks were printed on
pink paper.  "Pink Sheet" stocks have both advantages and disadvantages. 

  1. Thinly traded.  Can make it tough (and expensive) to buy or sell
  2. Bid/Ask spreads tend to be pretty steep.  So if you bought today
     the stock might have to go up 40-80% before you'd make money. 
  3. Market makers may be limited.  Much discussion has taken place in
     this group about the effect of a limited number of market makers on
     thinly traded stocks.  (They are the ones who are really going to
  4. Can be tough to follow.  Very little coverage by analysts and

  1. Normally low priced.  Buying a few hundred share shouldn't cost a
  2. Many companies list in the "Pink Sheets" as a first step to getting
     listed on the National Market.  This alone can result in some price
     appreciation, as it may attract buyers that were previously wary. 

In other words, there are plenty of risks for the possible reward, but
aren't there always?

The National Quotation Bureau maintains the list of pink-sheet stocks. 
Their site gives the history of the pink-sheet listing service and
information about real-time quotes for OTC issues.

Online quotes are offered by the National Quotation Bureau for
registered users only.

--------------------Check for updates------------------

Subject: Trading - Price Improvement

Last-Revised: 26 Feb 1997
Contributed-By: John Schott (jschott at, Chris Lott (
contact me )

In a nutshell, price improvement means that your broker filled an order
at a price better than you might have expected from the bid and asked
prices prevailing at the time you placed the order.  More concretely,
you were able to pay less than the asked price if you bought, and you
received better than the bid price if you sold.  Two of the ways that
this happens imply extra work by your broker, the third is just luck. 

First, a market order may be filled inside the spread.  For example, a
market order for 100 sh of IBM means that your broker should just buy
the shares for you at the current asking price.  If the price you pay is
less than the current asking price, you experienced price improvement

Second, a limit order may be filled better than the limit.  For example,
if you wanted to buy 100 sh of IBM at a maximum price of 150, and you
were filled at 149 7/8, that's price improvement also. 

And third, the market may simply have moved in your favor during the
time it took to route your order to the exchange, resulting in a lucky
saving for you. 

Price improvement is extremely important to people who frequently trade
large blocks of stocks.  These people care more about superior
executions (i.e., price improvement) than the brokerage house's
commission.  After all, a 1/8-point improvement on a 1000-share trade
makes a $125 difference.  So beware saving a penny on the commission and
losing a pound on the execution price. 

It is difficult for the small investor to determine independently
whether his or her order was filled with price improvement or not.  (I'm
assuming that the average small investor doesn't have access to a
live/delayed data feed.) However, there are several sources on the net
for intraday price charts that may help you analyze your fills.  On a
lightly traded stock, spotting you own trade crossing the tape is easy -
and a minor thrill. 

In theory, when you place an order with a broker, the broker should
search all possible places (be they markets or market makers) to get the
best possible execution price for you.  This is especially true with
NASDAQ, where a host of market makers may trade in a given stock.  In
fact, many brokers (especially discounters or so-called "introducing
brokers") simply dump their order on another firm for execution.  This
broker may not be so diligent in checking out all possible sources, due
to a custom called "Payment for Order Flow" (PFOF).  PFOF is a small
(typically $0.03-0.06/share) payment made by the executing broker to the
your broker for the privilege of handling the order.  If you think about
it, the money can only come from someone's pocket - and it might be from
yours via a less than top-flight execution. 

For many stocks, remember that there are a lot of places it may trade
beyond the exchange it is listed on.  Some large firms are trade on
exchanges from Tokyo to London.  Domestically, the same is true.  For
example, the Philadelphia stock exchange specialists make a market
(i.e., offer quotes) on any stock listed on the NYSE.  And then there
are alternate (mostly electronic markets), like Reuters' Instinet. 

Moreover, big brokers often have a small inventory of actively traded
stocks they make a market in and can effectively cut-off (cross) an
order before it hits the exchanges.  A brokerage house can also program
its computer to recognize when two orders flowing in from their regional
offices make a pairing that can be summarily crossed.  Generally, the
broker keeps the spread, but some brokers give the advantage to the
customer.  Most notable in this respect is Schwab's new "no spread"
trading system which crosses customer orders for participants.  Instead
of executing your order on the normal markets immediately, Schwab routes
it to their "waiting room".  If there is another order there that mates
with yours the trade is immediate - if not, you sit there until that
mating order shows up.  In either case, Schwab takes its commission and
splits the spread with the two customers.  It remains to be seen how
well this idea works.  Evaluating the potential for a delayed trade and
the price volatility of the stock itself versus the spread savings will
make it difficult for an individual to decide whether to participate. 

Due to the need for speed, your broker might be more interested in
moving the order (and generating some PFOF revenue) than delaying the
trade while looking around for a better price.  For example, if you are
trying to beat an anticipated market move, paying an extra 1/8th to get
immediate execution can be a good investment. 

Some regular and discount brokerage houses now advertise that they
automatically attempt price improvement on all orders placed with them. 
One small West Coast discounter recently advertised that about 38% of
its order flow achieved price improvement. 

All this discussion shows that price improvement requires a little more
work (and perhaps a little less profit) for the dealing brokers when
compared to straight trading.  It also shows that you should understand
your broker's normal practice when you consider how and where to place
your orders. 

Related topics include the recent SEC-NASDAQ settlement. 

--------------------Check for updates------------------

Subject: Trading - Process Date

Last-Revised: 23 Oct 1997
Contributed-By: Art Kamlet (artkamlet at, Chris Lott ( contact
me )

Transaction notices from any broker will generally show a date called
the process date.  This is when the trade went through the broker's
computer.  This date is nearly always the same as the trade date, but
there are exceptions.  One exception is an IPO; the IPO reservation
could be made a week in advance and until a little after the IPO has
gone off, the broker might not know how many shares his firm was
allocated so doesn't know how many shares a buyer gets.  A day or two
after the IPO has gone off, things might settle down.  (The IPO
syndicate might be allowed to sell say 10% more shares than obligated to
sell - and might sell those even after the IPO date "as of" the IPO
date.) So a confirmation might list a trade date that is two days before
the process date.  Other times the broker might have made an error and
admit to it, and so correct it "as of" the correct date.  So the
confirmation slip might show August 15 as the process date of a trade
"as of" a trade date of August 12.  It happens. 

--------------------Check for updates------------------

Subject: Trading - Round Lots of Shares

Last-Revised: 21 Mar 1998
Contributed-By: Art Kamlet (artkamlet at, buddyryba at, Uncle Arnie (blash404 at

There are some advantages to buying round lots, i.e., multiples of 100
shares, but if they don't apply to you, then don't worry about it. 
Possible limitations on odd lots (i.e., lots that are not multiples of
100) are the following:
   * The broker might add 1/8 of a point to the price -- but usually the
     broker will either not do this, or will not do it when you place
     your order before the market opens or after it closes. 
   * Some limit orders might not be accepted for odd lots. 
   * If these shares cover short calls, you usually need a round lot. 
   * If you want to write covered calls, you'll need a round lot.  Other
than that, there's just nothing magic about selling 100 shares or 59
shares or any other number. 

Don't be concerned that your order to buy or sell 59 shares won't be
considered until all 100-share orders are run.  Your order doesn't just
sit there waiting for an exact match on stocks that trade actively. 
Your order will likely just be swept into the specialist/market
makers/brokers trading account along with other items. 

If you're buying very small numbers of stocks priced under $100 or so,
your biggest problem is to find a broker who will bother with the order
and give reasonable commission.  The discounters may not touch the small
order or charge more - and a lot of bigger firms have minimum
commissions of $35 - 75 or so.  Many firms want a minimum size account
to open one, too. 

If you're trading penny stocks (commonly defined as having a price under
$5 per share), there may be additional restrictions.  For example, one
reader reports that on the Toronto exchange, a round lot for an issue
priced under CDN$1 is 500 shares. 

This seems like a good place to mention the terminology for very big
orders.  Block trades are large trading orders (very round lots?), where
large is defined by the stock exchange.  On the NYSE, a block trade is
any transaction in which 10,000 shares or more of a single stock are
traded, or a transaction with a value of $200,000 and up. 

So why does an investor still hear so much about odd lots? Well, once
upon a time, there was a difference.  At that time, if you wanted to
sell 100 shares, your order would be forwarded to an NYSE or AMEX floor
broker, who would then trek over to the trading area for that particular
stock and try to find a buyer.  If you wanted to sell only 50 shares,
the floor broker would instead hoof it over to an odd lot broker.  If
you were in a hurry and specified "no print," the odd lot broker would
buy the 50 shares at one eighth of a point below the posted bid price
for the stock.  Otherwise, the trade would go through at one eighth off
the next trade (one quarter point if over $40/share).  But all this is
ancient history. 

The "odd lot differential" of one eighth or one quarter of a point was
one of the ways that the odd lot broker made money.  But these days,
there are no odd lot brokers--and hence no odd lot differentials.  Small
stock trades, whether for 50 shares or 100 shares, are handled by
computer rather than by people. 

The only thing that's left of the odd lot broker system is a reluctance
by many people to place orders for less than 100 shares.  At one time,
these orders were subject to the odd lot differential, so people learned
to avoid them whenever possible.  The notion that orders of less than
100 shares were bad entered the investment world's folk lore, and like
many other sorts of folk wisdom, it has a remarkable ability to persist
even though it is no longer justified by the facts. 

--------------------Check for updates------------------

Subject: Trading - Security Identification Systems

Last-Revised: 8 Aug 2000
Contributed-By: Chris Lott ( contact me ), Peter Andersson (peter at

This article lists some of the identification systems used to assign
unique numbers to securities that are traded on the various exchanges
around the world. 
   * CUSIP
     A numbering system used to identify securities issued by U.S.  and
     Canadian companies.  Every stock, bond, and other security has a
     unique, 9-digit CUSIP number chosen according to this system.  The
     first six digits identify the issuer (e.g., IBM); the next two
     identify the instrument that was issued by IBM (e.g., stock, bond);
     and the last digit is a check digit.  The system was developed in
     the 1960's by the Committee on Uniform Security Identification
     Procedures (CUSIP), which is part of the American Banker's
     Association.  For a full history and all the gory details of the
     numbering system, see their web site:
   * CINS
     The CUSIP International Numbering System (CINS) is a close cousin
     to CUSIP.  Like CUSIP, it is a 9-digit numbering scheme that is
     used by the US finance industry.  Unlike CUSIP, the numbers are
     used to identify securities that are traded or issued by companies
     outside the US and Canada. 
   * EPIC
     Commonly used on the UK stock market. 
   * ISID
     The International Securities Identification Directory (ISID) is a
     cross reference for the many different identification schemes in
     use.  ISID Plus seems to be an expanded version of ISID (allowing
     more characters in the identifier). 
   * ISIN
     An International Securities Identification Number (ISIN) code
     consists of an alpha country code (ISO 3166) or XS for securities
     numbered by CEDEL or Euroclear, a 9-digit alphanumeric code based
     on the national securities code or the common CEDEL/Euroclear code,
     and a check digit. 
     The Association of National Numbering Agencies (ANNA) makes
     available International Securities Identification Numbers (ISIN) in
     a uniform structure.  More information is available at:
   * QUICK
     A numbering system used in Japan (anyone know more?). 
   * RIC
     Reuters Identification Code, used within the Reuters system to
     identify instruments worldwide.  Contains an X character market
     specific code (can be the CUSIP or EPIC codes) followed by .YY
     where YY stand for the two digit country code.  i.e IBM in UK would
     be IBM.UK.  More information is available at
   * SEDOL
     Stock Exchange Daily Official List.  The stock code used to
     identify all securities issued in the UK or Eire.  This code is the
     basis of the ISIN code for UK securities and consists of a 7-digit
     number allocated by the master file service of the London Stock
     A 5-digit code allocated to French securities (Socie'te'
     Interprofessionelle pour la Compensation des Valeurs Mobili`eres). 
   * Valoren
     Telekurs Financial, the Swiss numbering agency, assigns Valoren
     numbers to identify financial instruments.  This seems to be the
     CUSIP of Switzerland.  For much more information, visit the
handbook of world stock, derivative and commodity exchanges
(subscription required):

--------------------Check for updates------------------

Subject: Trading - Shorting Stocks

Last-Revised: 9 Mar 2000
Contributed-By: Art Kamlet (artkamlet at, Rich Carreiro (rlcarr

Shorting means to sell something you don't own. 

If I do not own shares of IBM stock but I ask my broker to sell short
100 shares of IBM I have committed shorting.  In broker's lingo, I have
established a short position in IBM of 100 shares.  Or, to really
confuse the language, I hold 100 shares of IBM short. 

Why would you want to short?

Because you believe the price of that stock will go down, and you can
soon buy it back at a lower price than you sold it at.  When you buy
back your short position, you "close your short position."

The broker will effectively borrow those shares from another client's
account or from the broker's own account, and effectively lend you the
shares to sell short.  This is all done with mirrors; no stock
certificates are issued, no paper changes hands, no lender is identified
by name. 

My account will be credited with the sales price of 100 shares of IBM
less broker's commission.  But the broker has actually lent me the stock
to sell.  No way is he going to pay interest on the funds from the short
sale.  This means that the funds will not be swept into the customary
money-market account.  Of course there's one exception here: Really big
spenders sometimes negotiate a full or partial payment of interest on
short sales funds provided sufficient collateral exists in the account
and the broker doesn't want to lose the client.  If you're not a really
big spender, don't expect to receive any interest on the funds obtained
from the short sale. 

If you sell a stock short, not only will you receive no interest, but
also expect the broker to make you put up additional collateral.  Why?
Well, what happens if the stock price goes way up? You will have to
assure the broker that if he needs to return the shares whence he got
them (see "mirrors" above) you will be able to purchase them and "close
your short position." If the price has doubled, you will have to spend
twice as much as you received.  So your broker will insist you have
enough collateral in your account which can be sold if needed to close
your short position.  More lingo: Having sufficient collateral in your
account that the broker can glom onto at will, means you have "cover"
for your short position.  As the price goes up you must provide more

When you short a stock you are essentially creating a new shareholder. 
The person who held the shares in a margin account (the person from whom
the broker borrowed the shares on the short seller's behalf) considers
himself or herself a shareholder, quite justifiably.  The person who
bought the (lent) shares from the the short seller also considers
himself or herself a shareholder.  Now what happens with the dividend
and the vote? The company sure as heck isn't going to pay out dividends
to all of these newly created shareholders, nor will it let them vote. 
It's actually fairly straightforward. 

If and when dividends are paid, the short seller is responsible for
paying those dividends to the fictitious person from whom the shares
were borrowed.  This is a cost of shorting.  The short seller has to pay
the dividend out of pocket.  Of course the person who bought the shares
might hold them in a margin account, so the shares might get lent out
again, and so forth; but in the end, the last buyer in the chain of
borrowing and shorting transactions is the one who will get the dividend
from the company Tax-wise, a short seller's expense of paying a dividend
to the lender is treated as a misc investment expense subject to the 2%
of AGI floor.  It does not affect basis (though I believe there is an
exception that if a short position is open for 45 days or less, any
dividends paid by the short seller are capitalized into basis instead of
being treated as an investment expense -- check the latest IRS Pub 550). 

Voting of shares is also affected by shorting.  The old beneficial owner
of a share (i.e., the person who lent it) and the new beneficial owner
of the share both expect to cast the vote, but that's impossible--the
company would get far more votes than shares.  What I have heard is that
in fact the lender loses his chance to vote the shares.  The lender
doesn't physically have the shares (he's not a shareholder of record)
and the broker no longer physically has the shares, having lent them to
the short seller (so the broker isn't a shareholder of record anymore,
either).  Only a shareholder-of-record can vote the shares, so that
leaves the lender out.  The buyer, however, does get to vote the shares. 
Implicit in this is that if you absolutely, positively want to guarantee
your right to vote some shares, you need to ask your broker to journal
them into the cash side of your account in time for the record date of
the vote.  If a beneficial owner whose broker lent out the shares
accidentally receives the proxy materials (accidentally because the
person is not entitled to them), the broker should have his computers
set up to disallow that vote. 

Even if you hold your short position for over a year, your capital gains
are taxed as short-term gains. 

A short squeeze can result when the price of the stock goes up.  When
the people who have gone short buy the stock to cover their previous
short-sales, this can cause the price to rise further.  It's a death
spiral - as the price goes higher, more shorts feel driven to cover
themselves, and so on. 

You can short other securities besides stock.  For example, every time I
write (sell) an option I don't already own long, I am establishing a
short position in that option.  The collateral position I must hold in
my account generally tracks the price of the underlying stock and not
the price of the option itself.  So if I write a naked call option on
IBM November 70s and receive a mere $100 after commissions, I may be
asked to put up collateral in my account of $3,500 or more! And if in
November IBM has regained ground and is at $90, I would be forced to buy
back (close my short position in the call option) at a cost of about
$2000, for a big loss. 

Selling short is seductively simple.  Brokers get commissions by showing
you how easy it is to generate short term funds for your account, but
you really can't do much with them.  My personal advice is if you are
strongly convinced a stock will be going down, buy the out-of-the-money
put instead, if such a put is available. 

A put's value increases as the stock price falls (but decreases sort of
linearly over time) and is strongly leveraged, so a small fall in price
of the stock translates to a large increase in value of the put. 

Let's return to our IBM, market price of 66 (ok, this article needs to
be updated).  Let's say I strongly believe that IBM will fall to, oh, 58
by mid-November.  I could short-sell IBM stock at 66, buy it back at 58
in mid-November if I'm right, and make about net $660.  If instead it
goes to 70, and I have to buy at that price, then I lose net $500 or so. 
That's a 10% gain or an 8% loss or so. 

Now, I could buy the IBM November 65 put for maybe net $200.  If it goes
down to 58 in mid November, I sell (close my position) for about $600,
for a 300% gain.  If it doesn't go below 65, I lose my entire 200
investment.  But if you strongly believe IBM will go way way down, you
should shoot for the 300% gain with the put and not the 10% gain by
shorting the stock itself.  Depends on how convinced you are. 

Having said this, I add a strong caution: Puts are very risky, and
depend very much on odd market behavior beyond your control, and you can
easily lose your entire purchase price fast.  If you short options, you
can lose even more than your purchase price!

One more word of advice.  Start simply.  If you never bought stock start
by buying some stock.  When you feel like you sort of understand what
you are doing, when you have followed several stocks in the financial
section of the paper and watched what happens over the course of a few
months, when you have read a bit more and perhaps seriously tracked some
important financials of several companies, you might -- might -- want to
expand your investing choices beyond buying stock.  If you want to get
into options (see the article on options ), start with writing covered
calls.  I would place selling stock short or writing or buying other
options lower on the list -- later in time. 

--------------------Check for updates------------------

Subject: Trading - Shorting Against the Box

Last-Revised: 5 Jul 1998
Contributed-By: Rich Carreiro (rlcarr at

This article discusses a strategy that once helped investors delay a
taxable event with relative ease.  Revisions made to the tax code by the
act of 1997 effectively eliminated the "Short Against The Box" strategy
as of July 27, 1997 (although not totally - see the bottom of this
article for a caveat). 

Shorting-against-the-box is the act of selling short securities that you
already own.  For example, if you own 200 shares of FON and tell your
broker to sell short 200 shares of FON, you have shorted against the
box.  Note that when you short against the box, you have locked in your
gain or loss, since for every dollar the long position gains, the short
position will lose and vice versa. 

An alternative way to short against the box is to buy a put on your
stock.  This may or may not be less expensive than doing the short sale. 
The IRS considers buying a put against stock the same as shorting
against the box. 

The name comes from the idea of selling short the same stock that you
are holding in your (safety deposit or strong) box.  The term is
somewhat meaningless today, with so many people holding stock in street
name with their brokers, but the term persists. 

The obvious way to close out any short-against-the-box position is to
buy to cover the short position and to sell off the long.  This will
cost you two commissions.  The better way is to simply tell your broker
to deliver the shares you own to cover the short.  This transaction is
free of commission at some brokers. 

The sole rationale for shorting-against-the-box is to delay a taxable
event.  Let's say that you have a big gain on some shares of XYZ.  You
think that XYZ has reached its peak and you want to sell.  However, the
tax on the gain may leave you under-withheld for the year and hence
subject to penalties.  Perhaps next year you will make a lot less money
and will thus be in a lower bracket and therefore would rather take the
gain next year.  Or maybe you have some other reason. 

Or perhaps you think, "This is great! I have a stock that I've held for
9 months but I think it has peaked out.  Now I can lock in my gain, hold
it for 3 more months, and then get a long-term gain instead of a
short-term gain, saving me a bundle in taxes!"

Bzzt.  The answer is absolutely NOT! Unfortunately, the IRS has already
thought of this idea and has set the rules up to prevent it.  From IRS
Publication 550:

     If you held property substantially identical to the property
     sold short for one year or less on the date of short sale or
     if you acquire property substantially identical to the
     property sold short after the short sale and on or before the
     date of closing the short sale, then:
        * Rule 1.  Your gain, if any, when you close the short sale
          is a short-term capital gain; and
        * Rule 2.  The holding period of the substantially
          identical property begins on the date of the closing of
          the short sale or on the date of the sale of this
          property, whichever comes first. 

So if you have held a stock for 11 months and 25 days and sell short
against the box, not only will you not get to 12 months, but your
holding period in that stock is zeroed out and will not start again
until the short is closed.  Note that your holding period is not
affected if you are already holding the stock long-term. 

The 1997 revisions to the tax code define (or extend) the idea of
"constructive sales." A constructive sale is a set of transactions which
removes one's risk of loss in a security even if the security wasn't
actually disposed of.  Shorting against the box as well as certain
options and futures transactions are defined as being constructive
sales.  And any constructive sale is interpreted as being the same as a
real sale, which is why this strategy is no longer effective (don't you
hate it when the rules change in the middle of the game?). 

For those who have read this far, there does appear to be a small
loophole in the 1997 revisions that permit shorting against the box to
delay a taxable event.  If you have a short against the box position and
then buy in the short within 30 days of the start of the tax year and
leave the long position at risk for at least 60 days before ofsetting it
again, the constructive sales rules do not apply.  So it appears that
you can continue shorting against the box to defer gains, but you have
to temporarily cover the short and be exposed for at least 60 days at
the beginning of each and every year. 

--------------------Check for updates------------------

Subject: Trading - Size of the Market

Last-Revised: 26 Apr 1997
Contributed-By: Timothy M.  Steff (tim at, Chris Lott (
contact me )

The "size of the market" refers to the number of shares that a
specialist or market maker is ready to buy or sell.  This number is
quoted in round lots of 100 shares; i.e., the last two zeros are
dropped.  The size of the market information is supplied with a quote on
professional data systems.  For example, if you get a quote of "bid 10,
offer 10 1/4, size 10 X 10" this means that the person or company is
willing to buy 10 round lots (i.e., 1,000 shares) at 10, or sell you
1,000 shares at 10 1/4. 

Specialists report size, they do not create it.  It seems that different
specialists report the size in approximately three ways:
  1. Some are very precise; if a quote is 10x10 and 100 trades the
     offer, the size then becomes 10x9. 
  2. Some use what seems to be a convention number.  That is if there
     the size is 50x100 the specialist is reporting at least 5,000
     shares bid but less than 10,000, and at least 10,000 shares offered
     but less than 25,000. 
  3. Some seem to have no discernable method as the trading seems to be
     unrelated to the reported size.  Thousands of shares trade the bid,
     the price and size remain the same, for example.  The floor brokers
in front of the specialist may be more important than the specialist in
this regard; the specialist is not necessarily a party to the trade as
is an OTC market-maker; the brokers may or may not put their orders into
the specialists' limit order book, or may cancel their orders in the
book later.  The floor brokers are able to change the size by bidding
and offering, and cancelling existing orders, thereby affecting how
others trade. 

On the NASDAQ, which is not an auction market, size is usually reported
as 500 X 500. 

--------------------Check for updates------------------

Subject: Trading - Tick, Up Tick, and Down Tick

Last-Revised: 27 Aug 1999
Contributed-By: Chris Lott ( contact me )

The term "tick" refers to a change in a stock's price from one trade to
the next (but see below for more).  Really what's going on is that a
comparison is made between trades reported on the ticker.  If the later
trade is at a higher price than the earlier trade, that trade is known
as an "uptick" trade because the price went up.  If the later trade is
at a lower price than the earlier trade, that trade is known as a
"downtick" trade because the price went down. 

On a traditional stock exchange like the NYSE, there is a single
specialist for each stock, so this measure can be calculated based on
the trade data.  On the NASDAQ, the tick measure is calculated based on
the trades reported (which might well be out of order, delayed, etc.)

Something called the "tick indicator" is a market indicator that tries
to gauge how many stocks are moving up or down in price.  The tick
indicator is computed based on the last trade in each stock. 

Note that certain transactions, namely shorting a stock, can only be
executed on an up tick, so this measure is used to regulate the markets
(it's not just of academic curiosity).  Interestingly, on the NASDAQ,
the restriction on short sales is not done based on the tick but rather
based on the change in the BID on a stock; i.e., from the stream of bid
data.  All Market Makers and ECN's who trade on NASDAQ have their change
in bids reported one at a time.  For example, if a NASDAQ issue trades
at 100 then next trades at 101 but at the same time the bid goes from
101 to 100 15/16, that would cause a down tick for the purpose of
regulating short sales.  The last trade was higher than the trade before
(so the traditional tick indicator is positive), but a drop in the bid
from 101 to 100 15/16 caused the would result in short sales being

The Wall Street Journal publishes a short tick indicator table daily
with the UP/DOWN cumulative ticks (tick-volume) for selected (i.e.,
leading) stocks. 

--------------------Check for updates------------------

Subject: Trading - Transferring an Account

Last-Revised: 9 Jan 1997
Contributed-By: anonymous; please contact Chris Lott ( contact me )

Transferring an account from one brokerage house to another is a simple,
painless process.  The process is supported by the Automated Customer
Account Transfer (ACAT) system.  To transfer your account, you fill out
an ACAT form in cooperation with your new broker.  The new broker will
generally require a copy of your statements from the old brokerage
house, plus some additional proof of identity.  The transfer will be
made within about 5-10 business days for regular accounts, and 10-15
business days for IRA and other types of qualified retirement accounts. 
The paperwork starts the process, but thereafter it's all done

There is one caveat.  Some brokerage houses charge fees as high as $50
to close IRA accounts.  Other houses (Quick & Reilly is one) will
reimburse you some fixed amount to cover those fees.  Be sure to ask,
the answer may delight you. 

--------------------Check for updates------------------

Compilation Copyright (c) 2005 by Christopher Lott.

User Contributions:

Gerri Pisciotta
My employer accidentally advised the company handling the 401k investment that I had been terminated, when in fact I had not. As a result, withdrawals discontinued from my pay and I missed a couple years of contributions. Since I never withdrew from the plan, is my employer liable for making up these contributions? If I made a lump sum catchup contribution,could they do the same?
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Truly lots of awesome tips!
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