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Section 3: Understanding Trading, Customer Accounts and Prohibited Activities (31% of SIE Exam)

This section is about how you place orders, how your account is set up, and the strict rules that brokers must follow.

1. How Trading Works

When you want to buy or sell a stock, you don't just yell "Buy!" into the void. You place specific types of "Orders".

  • Market Order: You tell your broker, "Buy this stock right now at whatever the current price is." This guarantees the trade will happen immediately, but it doesn't guarantee what price you will pay.
  • Limit Order: You tell your broker, "I only want to buy this stock if the price drops to $50." This guarantees the price you pay, but it does NOT guarantee the trade will ever happen (if the stock never drops to $50, you don't get it).

2. Types of Customer Accounts

Before you can trade, you have to open an account with a broker.

  • Cash Account: Very simple. If you want to buy $500 of stock, you must have $500 of cash in your account. No borrowing allowed.
  • Margin Account: Think of this like a credit card for stocks. You can borrow money from your broker to buy more stock than you actually have cash for. It magnifies your gains, but it also magnifies your losses. It is very risky.
  • Joint Account: An account owned by two or more people (like a husband and wife).

3. Prohibited Activities (What you CANNOT do)

The financial industry is heavily regulated to prevent cheating. If a broker does these things, they lose their license or go to jail.

  • Insider Trading: Trading stocks based on secret, non-public information. (E.g., you work at Apple, you know the new iPhone explodes, and you sell your stock before the news hits the public).
  • Market Manipulation: Trying to artificially pump up or crash a stock's price by spreading rumors or doing fake trades.
  • Commingling: A broker is never allowed to mix their personal money with a customer's money.
  • Front-Running: A broker gets a massive order from a client that will push the stock price up. Before executing the client's order, the broker buys the stock for their own personal account to make a quick profit. Highly illegal.

Key Terms Glossary

  • Margin: Borrowed money used to purchase securities.
  • Market Order: An order to buy or sell immediately at the best available current price.
  • Front-Running: The illegal practice of a broker executing trades for their own account before filling a customer's large order.

Mini-Quiz

Q1. A customer wants to buy 100 shares of XYZ stock but ONLY if they can get it for $30 or less. What type of order should they place?

  1. Market Order
  2. Limit Order
  3. Margin Order

Answer: B. A limit order sets a maximum price the buyer is willing to pay.

Q2. A broker overhears the CEO of a company in a restaurant saying they are going bankrupt tomorrow. The broker immediately sells all their clients' shares in that company. What violation occurred?

  1. Commingling
  2. Insider Trading
  3. Front-Running

Answer: B. The broker traded on material, non-public information.