FINRA Manual: Contents
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16-19 FINRA Issues Guidance Regarding the Use of Stop Orders During Volatile Market Conditions
FINRA Rule 5350
FINRA Rule 6121
FINRA Rule 6190
FINRA Rule 11892
Extraordinary Market Volatility
FINRA encourages firms to review their practices regarding stop (or stop-loss) orders, with an emphasis on educating investors regarding the risks and benefits of stop orders and special considerations around the use of stop orders during volatile market conditions. To accomplish this, firms should consider, among other things, providing targeted training to registered representatives regarding the risks associated with stop orders and, where appropriate, making alternative recommendations to meet customer objectives. Firms that allow customers to enter stop orders directly online should ensure that they prominently provide clear and comprehensive disclosures to customers at the time of order entry. Firms should also consider implementing systemic safeguards around the use of stop orders.
Questions regarding this Notice should be directed to:
On occasion U.S. equity markets experience periods of extraordinary volatility and price dislocation; sometimes these occurrences are prolonged and at other times they are of limited duration. FINRA and other self-regulatory organizations have instituted regulatory safeguards to help address potentially destabilizing market volatility, including recalibrating the market-wide circuit breakers,1 revising clearly erroneous transactions rules,2 and implementing limit up/limit down price bands and trading pauses.3 Nonetheless, significant price volatility may still occur and regulators and market participants have been exploring possible causes and contributing factors, including the role that stop orders and market orders may play in contributing to downward price pressure and market volatility.
Registered representatives often recommend, and investors use, stop orders as a tool for managing market risk.4 Investors generally use stop sell orders to protect a profit position in the event the stock's price declines. Investors with a short position generally use stop buy orders to limit losses in the event the stock's price increases. However, because stop orders, once triggered, become market orders, investors immediately face the same risks inherent with market orders—particularly, that during volatile market conditions, their orders may be executed at prices materially above or below their price expectations.
FINRA is issuing this Notice to encourage firms to (1) educate registered representatives on advising their customers regarding the use of stop orders; (2) disclose risks prominently where investors are able to enter stop orders directly online; (3) review their customer base to determine whether any safeguards should be put into effect around the availability and use of stop orders; and (4) consider whether systemic safeguards around the use of specific order types is appropriate.5
Disclosure to Customers
While stop orders may be a useful tool for investors who are unable to regularly monitor the price of their positions, stop orders are not without potential risks. Therefore, firms that encourage stop orders should educate their customers about the risks inherent in the use of stop orders. Firms that allow customers to enter stop orders directly online should ensure that they prominently provide clear and comprehensive disclosures to customers at the time of order entry, and registered representatives should do the same when advising their customers. For example, firms and registered representatives should inform customers that:
In addition to reviewing the order types made available to customers to determine whether current disclosures are sufficient, firms also should consider whether any systemic safeguards around the use of specific order types is appropriate. For example, with regard to stop orders, firms may consider:
1. Rule 6121.02 (Market-wide Circuit Breakers in NMS Stocks) generally provides that FINRA will halt all over-the-countertrading in all NMS stocks when a circuit breaker has been triggered on the primary listing market.
2. Rule 11892 (Clearly Erroneous Transactions in Exchange-Listed Securities) generally provides for uniform treatment across self-regulatory organizations of clearly erroneous reviews for executions in NMS stocks, including in the case of multi-stock events involving 20 or more securities.
3. FINRA Rule 6190 (Compliance with Regulation NMS Plan to Address Extraordinary Market Volatility) requires firms to comply with the NMS Plan to Address Extraordinary Market Volatility (the Plan), which provides for a market-wide limit up and limit down mechanism to prevent trades in NMS stocks from occurring outside of specified price bands, coupled with trading pauses in the event of more significant and prolonged price moves. The Plan generally prohibits the display of offers at prices below the lower price band and bids above the upper price band and the execution of trades outside the price bands.
4. FINRA Rule 5350 (Stop Orders) defines "stop order" and provides that a stop order must be triggered by a transaction at the stop price, rather than another trigger—e.g., a quotation at the stop price. Supplementary Material .01 further provides, among other things, that a firm may offer an order type that activates as a market or limit order using a triggering event other than a transaction at the stop price, however, such order cannot be labeled a "stop order" or a "stop limit order" and must be clearly distinguishable from a "stop order" or a "stop limit order." In addition, the firm must disclose to the customer, in paper or electronic form, prior to the time the customer places the order, a description of the order type including the triggering event. A firm that permits customers to engage in securities transactions online also must post the required disclosures on the firm's website in a clear and conspicuous manner.
A "stop" order is an order to buy (or sell) that becomes a market order to buy (or sell) when a transaction occurs at or above (below) the stop price. The "stop price" is the price, selected in advance by the investor, at which the order becomes a market order to buy (or sell). For a buy stop order, investors choose a stop price that is above the current market price for the security, whereas, for a sell stop order, investors would choose stop price that is below the current market price.
5. On April 19, 2016, the Equity Market Structure Advisory Committee (EMSAC) Customer Issues Subcommittee issued a status report recommending, among other things, that the SEC and FINRA consider issuing additional guidance to further emphasize the importance of effective practices relating to stop orders. See EMSAC Customer Issues Subcommittee Status Report.