APRIL 29: The Basics of Stock Trading

by David Jenyns on April 28, 2007

When someone uses the word “trade” in regard to stocks, they are referring to the act of buying or selling stocks. There are two main methods that stocks are traded: through the Internet or on the exchange floor.

The New York Stock Exchange (or NYSE) is a person-based stock trading system. The NYSE does handle a small percentage of its trading electronically, but the vast majority of trading is done on the stock exchange floor. The stock exchange floor is the most common image in people’s minds when they think of trading stocks. Within the chaos of hundreds of traders shouting and making gestures, shares are being traded. The process starts when the customer tells their broker to buy 50 shares of Company X at market. The broker then sends the order to a clerk located on the exchange floor.

The clerk finds a trader on the floor and informs them of the order. This trader then finds another trader who is willing to sell 50 shares of Company X stock. All traders on the floor are highly trained and know who is representing which brokerage firm and what stocks are available for trade. Next, the two floor traders agree on a price for the 50 shares and complete the transaction. The floor clerk is informed, who in turn informs the broker of the trade. The broker calls the customer back and discloses the final price. In a few days, the customer gets a confirmation by mail of the transaction. The actual time of the stock trade can take only a few minutes.

While this is a relatively simple process for a single trade, the practice can get a bit more complicated. There are more complex trades that take place on the stock market floor involving larger blocks of stocks. The fact that the New York Stock Exchange market handles one billion shares of trading every day is a marvel of modern times.

While the New York Stock Exchange is a person-based system, the NASDAQ stock exchange is handled entirely electronically. The NASDAQ system uses large computer networks to handle the process of matching buyers and sellers. This is in contrast to the NYSE’s process of using live brokers. The advantage of the NASDAQ is that the system is efficient and fast. Large institutional traders, like mutual funds and pension funds, prefer trading with the computerized NASDAQ system.

When an individual investor uses the NASDAQ system, they get almost instant confirmations on all trades. Some prefer this method because it puts the investor in more control of the investing removing the middle man and bringing them a step closer to the market. With NASDAQ there is no need for the floor clerk or floor trader, the computer system handles these tasks. With NASDAQ, however, there is still a need for a broker. Investors do not have access to the exchange market. The broker accesses the electronic network and arranges the trading. They login to the market to find the buyer or seller depending on the customer’s order.

With online investing, there are a variety of buy and sell orders that the individual investor can take advantage of in order to gain more control over the process. The most basic orders are market orders, limit orders and stop loss orders.

A market order is the simplest of these orders. It instructs the broker to buy or sell the stock at the market price. These are the most inexpensive orders since there aren’t many brokerage fees for market orders.

Limit orders are used to direct the broker to trade a stock at a particular price. The transaction will not be carried out until the requested stock reaches that price. The benefit of using limit orders is that they allow the investor to control their entry to and exit from the market. The one drawback is that limit orders may have much higher brokerage fees than market orders. An investor may be better off watching the market and placing a market order when their stock reaches the desired price.

Stop loss orders live up to their names. They stop further losses from occurring on stocks that are declining in price. A stop loss order establishes a price trigger. At the point that a stock reaches that price trigger, the brokerage will sell the stock. A stop loss order can be seen as a form of insurance to protect the investor from big drops in stock.

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