The Idea of Banning Market Orders Goes Mainstream

I believe that I was one of the pioneering voices of the idea, which some may view as Draconian, of banning the “market” order type.  Although I’m normally in favor of letting traders be as stupid as they want to be, it’s quite clear (evidenced by trade cancellations after the fact) that the regulators (and many others) do not agree.  Thus, as I wrote after the Flash Crash, back in May, 2010:

IF the NASDAQ wants to cancel trades that are at “crazy prices” – to use the subjective term – and I think it’s beyond debate that they do want to cancel such trades, since they already demonstrated such, THEN steps should be taken to prevent these trades from taking place in the first place.  There is no reason to allow these trades only to cancel them after the fact.  If you want to protect traders from themselves, then PROACTIVELY make sure that the trades can’t get printed unless people really want to trade at those prices.”

Now, Traders Magazing writes about how more brokers are talking about altering market orders so that they automatically get converted to a limit order (with a price a few % away from the inside market) by the receiving broker.   As the article notes, this results in some risk to the broker: if they put a price cap on an order that then doesn’t get filled.  It’s also noted that this risk is small and well worth the protection from large errors.   Of course, one problem that we’ve seen is that the NASDAQ has tended to cancel such erroneous trades, in some sense removing the incentive to protect oneself from committing them!   The article from Traders Magazine focuses mostly on institutional orders, but I think that retail brokers are the ones who really need to implement this protection.

I really said it all in my prior piece (linked twice, above, already), but the bottom line is that I’m quite confident that nearly 100% of the time an investor enters a MARKET ORDER, which means “REGARDLESS OF PRICE,” they do not really mean that they want their order executed regardless of price.  Thus, they shouldn’t enter market orders.  Instead of converting market orders internally into limit orders, Etrade, Schwab, Fidelity, Ameritrade, etc – should all remove “market” as an execution choice, since their customers are not informed enough to understand that they don’t really want to enter a market order.

related: Don’t Lose Faith in Markets, Lose Faith in Market Orders


Edit:  @itenginerd, via Twitter, asks: “Interesting idea, but the retails aren’t the ones causing the crazy prices. They’re just herd-panic. Takes some real volume ($) to clear through standing bids/asks and get to the “crazy” price levels. So the retails may be victims of it, but the smart money has to be driving that price action. No?”

It’s quite possible/probable that retail isn’t the main cause, and once we’ve made sure that retail isn’t the “cause,” then we don’t need to cancel orders anymore, right?  That’s one of my main goals – stop cancellations, increase accountability.  If you sell a stock down to 1c, well, as the Big Show says, “would NOT have.”  You now will have to live with it – and “I didn’t know a market order could get filled at 1c” is no longer an excuse.

Now, currently, we sure don’t want to tell Mom and Pop, “Sorry, Mrs. Johnson, but you entered a market order, you’re f*cked.”  So let’s not even let them enter that market order.  NEXT, when the T-1000 AlgoBot that everyone already hates sells ACN down to 1c, the reply, now that we know that market orders didn’t cause this problem, and that someone (be it human or computer, retail or professional) actually entered specific limit orders to sell the stock at that price, then they can be held accountable and not bailed out by cancellations!

There are still issues with typos of limit orders -like “Fat finger” errors when someone enters $100 as a price cap instead of $10, and they can also be easily remedied by having extra checks in place at order entry: “ARE YOU SURE YOU WANT TO ENTER A LIMIT PRICE THAT IS 500% AWAY FROM THE CURRENT INSIDE MARKET?”  Or by other changes like the ones mentioned in the Trader Magazine article – “suspicious” limits that seem erroneous can be adjusted to more reasonable limits.   We had all sorts of checks like these in our systems back when I used to trade on both the sell side and the buy side.

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