Stock Broker Market Structure & Trading Mechanics 2 — Questions and Answers
Question 1: What is 'Level 2' market data and who primarily uses it?
- Data showing only the last trade price; casual investors
- Real-time data showing all bid/ask quotes from all market makers; active traders and professionals (Correct answer)
- Data delayed by 20 minutes; free public data
- Historical daily price data; long-term investors
Correct answer: Real-time data showing all bid/ask quotes from all market makers; active traders and professionals
Level 2 market data shows real-time quotes from all market makers for a security, displaying the full depth of the order book, and is primarily used by active traders and market professionals.
Question 2: Which type of order becomes a market order once a specified price threshold is reached, often used to limit losses?
- Limit order
- Stop order (stop-loss order) (Correct answer)
- All-or-none order
- Fill-or-kill order
Correct answer: Stop order (stop-loss order)
A stop order (stop-loss) is set at a trigger price; once the security trades at or through that price, the stop converts to a market order and executes at the next available price.
Question 3: What is 'dark pool' trading?
- After-hours trading on public exchanges
- Private trading venues where large institutional orders are executed without pre-trade price transparency (Correct answer)
- Illegal insider trading networks
- Trading in commodities futures
Correct answer: Private trading venues where large institutional orders are executed without pre-trade price transparency
Dark pools are private exchanges or forums for trading securities where large institutional orders can be executed without revealing the order size or price to the public market before the trade occurs.
Question 4: What distinguishes a 'primary market' transaction from a 'secondary market' transaction?
- Primary markets are for bonds; secondary markets are for stocks
- Primary market is where new securities are first issued (IPO); secondary market is where existing securities are traded among investors (Correct answer)
- Primary markets are regulated; secondary markets are unregulated
- Primary markets are for institutional investors only
Correct answer: Primary market is where new securities are first issued (IPO); secondary market is where existing securities are traded among investors
In the primary market, issuers sell newly created securities (like in an IPO) directly to investors for the first time; in the secondary market, investors trade existing securities among themselves.
Question 5: What is the 'uptick rule' (Rule 10a-1 / Rule 201) related to short selling?
- A rule requiring stocks to rise 10% before dividends are paid
- A rule that restricts short selling of a stock that has declined more than 10% in one day (Correct answer)
- A requirement to report short positions above $10 million
- A rule limiting short selling to the opening hour of trading
Correct answer: A rule that restricts short selling of a stock that has declined more than 10% in one day
Rule 201 (the alternative uptick rule) restricts short selling of a security that has dropped more than 10% in a single day, requiring that subsequent short sales be made at a price above the national best bid.
Question 6: What is 'payment for order flow' (PFOF) and why is it controversial?
- A fee investors pay brokers for each order; controversial due to high costs
- A practice where brokers receive compensation from market makers for routing customer orders to them; controversial because it may create conflicts of interest (Correct answer)
- A method of paying exchange fees; controversial due to regulatory costs
- A commission structure for bond trades; controversial due to lack of transparency
Correct answer: A practice where brokers receive compensation from market makers for routing customer orders to them; controversial because it may create conflicts of interest
PFOF is compensation paid by market makers to brokers for directing customer orders to them; it's controversial because brokers may prioritize the paying market maker over finding the best execution price for customers.
Stock Broker Market Structure & Trading Mechanics 2
What is 'Level 2' market data and who primarily uses it?