Study guide
This chapter maps to FINRA SIE Section 3 (Understanding Trading, Customer Accounts and Prohibited Activities), specifically order types and strategies (3.1.1), trade settlement (3.1.3), account types and registrations (3.2.1-3.2.2), and suitability (3.2.5). This is the largest single domain on the exam, and questions tend to be scenario-based, requiring you to apply order-type mechanics and account rules rather than recall isolated facts.
Order Types: Market, Limit, and Stop Orders
A market order instructs immediate execution at the best available current price, guaranteeing execution but not a specific price. A limit order sets a maximum price a buyer will pay or a minimum price a seller will accept, guaranteeing price (or better) but not guaranteeing execution if the market never reaches that level. A buy limit order is placed below the current market price (a trader wants to buy cheaper) and a sell limit order is placed above the current market price (a trader wants to sell higher). A stop order (stop-loss order) becomes a market order once the stock trades at or through the specified stop price, used to limit a loss or protect a profit; a sell stop is placed below the current market price (to limit a loss on a long position) and a buy stop is placed above the current market price (commonly used to limit a loss on a short position or to protect a profit on a short sale). A stop-limit order combines both: once the stop price is triggered, it becomes a limit order at the specified limit price rather than a market order, which means it could still fail to execute in a fast-moving market. Orders may also carry time-in-force instructions: a day order expires at the end of the trading day if unfilled, while a good-till-canceled (GTC) order remains working until executed or canceled by the customer.
Order Qualifiers and Trading Strategies
Beyond basic order types, several qualifiers refine execution instructions. An all-or-none (AOO) order requires the entire order quantity to be filled in a single execution or not at all, but does not require immediate execution. A fill-or-kill (FOK) order must be executed immediately and completely, or it is canceled entirely. An immediate-or-cancel (IOC) order requires whatever quantity can be filled immediately to be filled, with the remainder canceled (partial fills are acceptable, unlike FOK). A not-held order gives the floor broker discretion over the timing and price of execution. Short selling involves selling borrowed shares with the expectation of buying them back later at a lower price to return to the lender and profit from the difference; because a stock's price can theoretically rise without limit, a short seller's potential loss is unlimited, contrasted with a long position where the maximum loss is limited to the amount invested. Buying on margin involves borrowing funds from the broker-dealer to purchase securities, using the securities as collateral, governed by Regulation T (initial margin, set by the Federal Reserve) and FINRA/exchange maintenance margin requirements; a margin call requires the customer to deposit additional funds or securities if equity falls below the maintenance requirement.
Trade Settlement and Regular-Way Settlement Cycles
Settlement is the process by which securities are delivered and payment is exchanged following a trade's execution date (trade date, or T). Regular-way settlement for most corporate and municipal securities transactions is one business day after the trade date (T+1). Regular-way settlement for U.S. government securities and options is also T+1 in the modern settlement environment. Parties can also negotiate cash settlement (same-day) for special circumstances, though this is uncommon. The record date is the date set by the issuer's board on which an investor must be the shareholder of record to receive a declared dividend. Since the SEC's move to T+1 settlement (effective May 28, 2024), the ex-dividend date is set on the same day as the record date: a purchase made on the record date settles one business day later, after the record date has passed, so that buyer does not receive the dividend, while a purchase made the prior business day settles on the record date and does qualify. A stock trading ex-dividend has its price reduced by approximately the dividend amount at the market open on the ex-date. Understanding which settlement cycle applies to which security type, and how it interacts with the ex-dividend mechanism, is a recurring exam theme, especially since settlement conventions have shortened in recent years and candidates should rely on current T+1 rules rather than older T+2 or T+3 assumptions.
Customer Account Types and Ownership Registrations
Accounts can be registered in several ways depending on ownership and control. An individual account has a single owner with sole authority over transactions. A joint account has two or more owners; joint tenants with rights of survivorship (JTWROS) means that upon one owner's death, that owner's interest automatically passes to the surviving owner(s), commonly used by spouses; tenants in common (TIC) means each owner's interest passes to their own estate, not automatically to the co-owner, often used by unrelated parties or business partners. A custodial account (UGMA/UTMA) is established by an adult custodian for the benefit of a minor; the account uses the minor's Social Security number for tax purposes, only one custodian and one minor per account is permitted, gifts into the account are irrevocable, and the custodian must act in the minor's best interest until the minor reaches the age of majority, at which point full control transfers to the (former) minor. A trust account is managed by a trustee for the benefit of designated beneficiaries per the trust document. Corporate and partnership accounts require documentation (such as a corporate resolution) establishing which associated persons have trading authority. A discretionary account grants a registered representative authority to make trading decisions (asset, action, and amount) without contacting the customer for each trade, but requires prior written authorization from the customer and principal approval of each discretionary order.
Retirement Accounts and Suitability
Retirement accounts receive special tax treatment under the Internal Revenue Code. A traditional IRA allows tax-deductible contributions (subject to income/coverage limits) with tax-deferred growth, taxed as ordinary income upon withdrawal; early withdrawals before age 59½ generally incur a 10% penalty in addition to ordinary income tax, absent an exception. A Roth IRA is funded with after-tax contributions (subject to income limits) but allows qualified withdrawals of both contributions and earnings tax-free, provided holding-period and age requirements are met. Employer-sponsored plans include 401(k) plans (private employers) and 403(b) plans (nonprofits/educational institutions), typically funded through employee salary deferrals, often with employer matching. Suitability is a core obligation: FINRA Rule 2111 (and Regulation Best Interest for broker-dealers recommending to retail customers) requires that a recommendation be suitable for, or in the customer's best interest given, the customer's investment profile — including age, financial situation, tax status, investment objectives, risk tolerance, time horizon, liquidity needs, and investment experience. Firms and representatives must have a reasonable basis to believe a recommendation is suitable, considering both the specific customer (customer-specific suitability) and, in some contexts, whether a strategy is suitable for any investor (reasonable-basis suitability). Know Your Customer (KYC) obligations require gathering this profile information at account opening and keeping it updated.
Key terms
- Limit order
- — An order that guarantees a maximum (buy) or minimum (sell) execution price but not that execution will occur.
- Stop order
- — Becomes a market order once the stock trades at or through the stop price; used to limit losses or protect gains.
- Fill-or-kill (FOK)
- — An order that must execute immediately and in full or be canceled entirely, with no partial fills allowed.
- Regular-way settlement
- — The standard settlement timeframe after trade date for a security type, generally one business day (T+1) for most equities, corporate/municipal bonds, and government securities.
- Ex-dividend date
- — Under the current T+1 cycle, the same day as the record date; a stock trades without the right to the next declared dividend from that date forward, with the price adjusted down accordingly.
- JTWROS
- — A joint account where a deceased owner's interest passes automatically to the surviving owner(s).
- UGMA/UTMA custodial account
- — An account held by an adult custodian for a minor's benefit; contributions are irrevocable and use the minor's Social Security number.
- Discretionary account
- — An account where a registered representative may place trades without the customer's prior approval of each order, requiring written authorization and principal review.
- Suitability
- — The requirement that a recommendation align with a customer's investment profile — objectives, risk tolerance, time horizon, and financial situation.
- Regulation T
- — The Federal Reserve rule setting initial margin requirements for securities purchased on credit.
Exam tips
- Draw a quick price line for buy/sell limit and stop orders: buy limits and sell stops sit below market; sell limits and buy stops sit above market — this rule solves most order-placement questions instantly.
- FOK demands immediate full execution or cancellation; IOC allows partial immediate fills; AON allows delay but never a partial fill — keep these three qualifiers straight, as they're routinely swapped in distractors.
- Short sellers face theoretically unlimited loss potential since a stock can rise indefinitely — a frequently tested asymmetry versus a long position's capped loss.
- On settlement questions, apply current T+1 conventions rather than older T+2/T+3 assumptions — and remember that under T+1, the ex-dividend date now falls on the same day as the record date, not one business day before it.
- JTWROS passes automatically to the survivor; tenants in common passes to the deceased's estate — a one-line distinction that resolves most joint-account inheritance questions.
- Discretionary trading always requires prior written customer authorization plus principal approval of each order — a 'the rep used judgment without permission' scenario is almost always the violation being tested.