Investing 101: 4 Stock Trading Rules

The following post was originally published on Debt Free Guys

If you only watched the news, you might think there are no rules on Wall Street. This, in fact, is not true. There are a lot of rules on Wall Street, maybe even too many. Quite honestly, it’s hard to keep up with all the rules, the various ruling bodies and all their changes. Some say, this makes it hard to enforce the rules that exist. That may or may not be by design.

If you’re new to investing or even familiar with investing and could use a refresher, we’ve written two posts that will highlight some of the fundamental rules for trading stocks and Exchange Traded Funds (ETFs). Not all trades go through the New York Stock Exchange (NYSE) on Wall Street, but these rules pretty much apply to all exchanges, no matter their location.

This first post will focus on specific stock trading violations. Our follow-up post will focus on margin violations.

1. Front Running

Front running occurs when one investor knowingly buys or sells ahead of another or other investors. This can allow them to obtain a better price and unfairly positions the cheated investor. A common scenario is when an advisor or broker trades ahead of their client. This create a conflict of interest, especially if an advisor trades at his own discretion in his client’s accounts.

2. Shadowing

Shadowing occurs when an investor knowingly mirrors the trades of another or other investors. This is sort of a “herd mentality” that allows the first investor to benefit from the knowledge of another or other investors.

3. Painting the Tape

Painting the tap occurs when traders collude to buy and/or sell to create the appearance of substantial trading activity for a particular security. This is often done to generate excitement about a stock so as to become appealing to those not included in the collusion. It’s, also, done to in a bit of a gamble to sell at the market high.

4. Free Ride

A free ride occurs when a trader buys stock in a cash account (different from a margin account discussed in our next post) and sells a stock without ever actually paying for it.

This is how it happens. The purchase of stocks takes three days to settle (T+3). If a trader buys a stock on a Monday, the trade won’t settle until Thursday. If a trader buys the stock on Monday, sells it on Tuesday, the trader committed a free ride violation because the trader never actually paid for the stock.

This can result in the trader’s account being frozen for up to 90 days on the first violation. This means that all buys must be paid for in cash on the date of the trade.

Those are four stock investing violations all traders should avoid. In our follow up post, we will discuss margin, the risks of margin and the trading violations that can be generated by investing on margin.

David Auten and John Schneider are The Debt Free Guys. After paying off over $51,000 in credit card debt, they have dedicated themselves to helping people live debt free, have fun and be Money Conscious. They are the authors of four books including 4: The Four Principles of a Debt Free Life available on Amazon now.

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