Hundreds of millions of shares of securities are traded daily on the stock markets in the United States. Every trade brings together a buyer and a seller to complete the transaction at a given price.
The Process of Trading Stocks
Assume you instruct brokerage firm A to purchase a certain number of shares at a specific price. The firm relays the buy order to its representative, who coordinates trading. Because the brokerage firm has a seat on the exchange, the buy order is then given to the brokerage firm’s contact person at the exchange a floor broker. This broker contacts a specialist, a person on the floor of the exchange who handles trades of that particular stock in an effort to maintain a fair and orderly market. The buy order is then filled, either by taking shares from the specialist’s own inventory or by matching it with another investor’s sell order.
Matched or Negotiated Stock Price
Securities prices are either matched or negotiated. Matched Price On the organized stock exchanges, a match must occur between the buyer’s price and the seller’s price for a sale to take place. Therefore, a specialist could hold a specific order for a few minutes, a few hours, or even a week before making a match. With actively traded issues, a transaction is completed in just a few minutes. A slower-selling security can be traded more quickly if an investor is willing to accept the current market price (as discussed later)
Negotiated Price. In the over-the-counter market, the final transaction price is negotiated because two prices are involved. The bid price is the highest price anyone has declared that he or she wants to pay for a security. Thus, it represents the amount a brokerage firm is willing to pay for a particular security. The ask price is the lowest price anyone will accept at that time for a particular security. Thus, it represents the amount for which another brokerage firm is willing to sell a particular security. The spread represents the difference between the bid price at which a broker/dealer will buy shares and the higher ask price at which the broker/dealer will sell shares. The spread can be as little as 5 cents per share, but it can range from 10 to 20 cents for OTC stocks. In addition to paying the ask price, investors typically pay a nominal sales commission to their stockbroker for executing the transaction. If a buyer does not want to pay the asking price, he or she instructs the stockbroker to offer a lower bid price, which may or may not be accepted. If it is refused, the buyer might cancel the first order and raise the bid slightly in a second order in the hope that the owner will sell the shares at that price. Otherwise, the buyer may have to pay the full ask price to complete the deal. OTC trades usually occur at prices somewhere between the bid and ask figures.
Types of Stock Orders
Basically, there are only two types of orders buy and sell. The stockbroker will buy or sell securities according to prescribed instructions in a process called executing an order. Those instructions can place constraints on the prices at which those orders are carried out. Following are examples of instructions
Market Order. A market order instructs the stockbroker to execute an order at the prevailing market price that is, the current selling price of the stock. A stockbroker can generally conduct the desired transaction within a few minutes. The floor broker tries to match the instructions from many investors with the narrow range of prices available from the specialist. Traders on the floor of the stock market typically shout and signal back and forth as part of this effort to match buyers and sellers. Most trades are market orders.
The Process of Trading Stocks
Assume you instruct brokerage firm A to purchase a certain number of shares at a specific price. The firm relays the buy order to its representative, who coordinates trading. Because the brokerage firm has a seat on the exchange, the buy order is then given to the brokerage firm’s contact person at the exchange a floor broker. This broker contacts a specialist, a person on the floor of the exchange who handles trades of that particular stock in an effort to maintain a fair and orderly market. The buy order is then filled, either by taking shares from the specialist’s own inventory or by matching it with another investor’s sell order.
Matched or Negotiated Stock Price
Securities prices are either matched or negotiated. Matched Price On the organized stock exchanges, a match must occur between the buyer’s price and the seller’s price for a sale to take place. Therefore, a specialist could hold a specific order for a few minutes, a few hours, or even a week before making a match. With actively traded issues, a transaction is completed in just a few minutes. A slower-selling security can be traded more quickly if an investor is willing to accept the current market price (as discussed later)
Negotiated Price. In the over-the-counter market, the final transaction price is negotiated because two prices are involved. The bid price is the highest price anyone has declared that he or she wants to pay for a security. Thus, it represents the amount a brokerage firm is willing to pay for a particular security. The ask price is the lowest price anyone will accept at that time for a particular security. Thus, it represents the amount for which another brokerage firm is willing to sell a particular security. The spread represents the difference between the bid price at which a broker/dealer will buy shares and the higher ask price at which the broker/dealer will sell shares. The spread can be as little as 5 cents per share, but it can range from 10 to 20 cents for OTC stocks. In addition to paying the ask price, investors typically pay a nominal sales commission to their stockbroker for executing the transaction. If a buyer does not want to pay the asking price, he or she instructs the stockbroker to offer a lower bid price, which may or may not be accepted. If it is refused, the buyer might cancel the first order and raise the bid slightly in a second order in the hope that the owner will sell the shares at that price. Otherwise, the buyer may have to pay the full ask price to complete the deal. OTC trades usually occur at prices somewhere between the bid and ask figures.
Types of Stock Orders
Basically, there are only two types of orders buy and sell. The stockbroker will buy or sell securities according to prescribed instructions in a process called executing an order. Those instructions can place constraints on the prices at which those orders are carried out. Following are examples of instructions
Market Order. A market order instructs the stockbroker to execute an order at the prevailing market price that is, the current selling price of the stock. A stockbroker can generally conduct the desired transaction within a few minutes. The floor broker tries to match the instructions from many investors with the narrow range of prices available from the specialist. Traders on the floor of the stock market typically shout and signal back and forth as part of this effort to match buyers and sellers. Most trades are market orders.
Limit Order. A limit order instructs the stockbroker to buy or sell a stock at a specific price. It may include instructions to buy at the best possible price but not above a specified limit, or to sell at the best possible price but not below a specified limit. A limit order provides some protection against buying a security at a price higher than desired or selling at a price deemed too low. The stockbroker transmits the limit order to the specialist. The order is executed if and when the specified price (or better) is reached and all other previously received orders on the specialist’s book have been considered.
A disadvantage for buyers who place a limit order is that they might miss an excellent opportunity. For example, assume you place a limit order with your stockbroker to buy 100 shares of Running Paws common stock at $60.50 or lower. You have read in the newspaper that the stock has recently been selling at $61 and $61.25, and you hope to save $0.50 to $1.00 on each share. On that same day, the company announces publicly that it plans to expand into the dog food area for the first time. Investor confidence in the new sales effort pushes the price up to $70. If you had given your stockbroker a market order instead, you would have purchased 100 shares of Running Paws at perhaps
$61.50, which would have given you an immediate profit of $850 ($70 - $61.50 = $8.50; $8.50 X 100 shares $850) on an initial investment of $6150 ($61.50 X 100). A disadvantage for sellers placing a limit order is that it could result in no sale if the price drops because of negative news. Assume that you bought stock at $50 that is currently selling at $58 and that you have placed a limit order to sell at a price of no less than $60 so as to take your profit. The price could creep up to $59 and then fall back to $48, however. In this event, you did not sell the securities because the limit order was priced too high, and they are now worth less than what you originally paid for them. A limit order is best used when you expect great fluctuations in the price of a stock and when you buy or sell infrequently traded securities on the over-the-counter market. Limit orders account for about one-third of all trades.
Stop Order (Stop-Loss Order). A stop order instructs a stockbroker to sell your shares of stock at the market price if a stock declines to or goes below a specified price. It is often called a stop-loss order because the investor uses it to protect against a sharp drop in price and thus to stop a loss. The specialist executes the order as soon as the stop-order price is reached and a buyer is matched at the next market price.
A disadvantage for buyers who place a limit order is that they might miss an excellent opportunity. For example, assume you place a limit order with your stockbroker to buy 100 shares of Running Paws common stock at $60.50 or lower. You have read in the newspaper that the stock has recently been selling at $61 and $61.25, and you hope to save $0.50 to $1.00 on each share. On that same day, the company announces publicly that it plans to expand into the dog food area for the first time. Investor confidence in the new sales effort pushes the price up to $70. If you had given your stockbroker a market order instead, you would have purchased 100 shares of Running Paws at perhaps
$61.50, which would have given you an immediate profit of $850 ($70 - $61.50 = $8.50; $8.50 X 100 shares $850) on an initial investment of $6150 ($61.50 X 100). A disadvantage for sellers placing a limit order is that it could result in no sale if the price drops because of negative news. Assume that you bought stock at $50 that is currently selling at $58 and that you have placed a limit order to sell at a price of no less than $60 so as to take your profit. The price could creep up to $59 and then fall back to $48, however. In this event, you did not sell the securities because the limit order was priced too high, and they are now worth less than what you originally paid for them. A limit order is best used when you expect great fluctuations in the price of a stock and when you buy or sell infrequently traded securities on the over-the-counter market. Limit orders account for about one-third of all trades.
Stop Order (Stop-Loss Order). A stop order instructs a stockbroker to sell your shares of stock at the market price if a stock declines to or goes below a specified price. It is often called a stop-loss order because the investor uses it to protect against a sharp drop in price and thus to stop a loss. The specialist executes the order as soon as the stop-order price is reached and a buyer is matched at the next market price.
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