How Stocks Are Traded
* Investors can trade stocks before and after the stock
exchanges open and close for the day
* The spreads between the bid and ask price on a stock can
be as low as 1 cent.
* With real-time quotes, prices of stocks are transparent.
THE STOCK EXCHANGES
A stock exchange is a marketplace where stocks of companies are
bought and sold. The stock markets in the United States consist of
the two major exchanges and an over-the-counter (OTC) market:
the New York Stock Exchange (NYSE) and the American Stock
Exchange (AMEX), which have trading floors where stocks are
traded, and the National Association of Securities Dealers
Automated Quotations System (Nasdaq), which is an OTC market
that trades primarily new, small-cap stocks of companies over telephone
lines and computer networks. A public company lists its
shares on one exchange by meeting the listing requirements of that
particular exchange. Stocks listed on one exchange can be bought
and sold on many exchanges, including the electronic computer
networks (ECNs), which are Internet-only exchanges.
The stock markets have changed significantly because of
advances in technology. The widespread use of personal computers
and, more specifically, the Internet has given investors direct
access to information that was unavailable previously. In addition,
daily trading hours for investors have been lengthened. Whereas
the stock markets were once open for trading only during specific
hours, after-hours trading now takes place. The exchanges still
close at the end of the official trading day (4:00 p.m., Eastern
Standard Time), but after-hours trades transpire via ECNs before
the market opens at 9:30 a.m. and after the market closes at 4:00
p.m. Eastern Standard Time (EST).
Trades on the NYSE are matched by specialists on the floor
through open-outcry auction (see “Auction Market” later in this
chapter), but the NYSE is moving toward allowing widespread
automatic matching of buy and sell orders like its rival Nasdaq.
One of the many advantages for investors using the Internet is
that they can trade securities online without directly contacting
a broker. Another advantage of the Internet is the greater stockpricing
transparency offered. In other words, you can see the price
that buyers and sellers are willing to settle on for a particular stock.
The function of the security markets is to provide continuous
and fair pricing. Buying and selling financial securities are auction
processes. A specialist submits a bid price (the amount he or she is
willing to pay), and a specialist submits an ask price (the amount at
which he or she wants to sell). If these prices do not match, the bid
and ask prices from other buyers and sellers are sought so that
trades can be made.
Efficient markets provide up-to-date prices for certain securities.
For stocks, you can get instantaneous prices through real-time
pricing on the Internet or by calling your broker. You can easily
obtain spreads between the bids and ask quotes for stocks. The
spread is the difference between the bid and ask prices.
The security markets in the United States are large, in that they
have many buyers and sellers. The larger the number of buyers and
sellers in a market, the more investors are assured of receiving fair
pricing. Use of the Internet, along with the viewing of stock information
on television stations (such as on CNBC and Bloomberg),
has provided stock-price transparency, where investors can see
changing prices from trade to trade, as well as the rapid transmittal
of information that affects stock prices. In efficient markets, stock
prices reflect all relevant information. Because stock prices in efficient
markets reflect all relevant information, little likelihood exists
that investors will trade their stocks at unfair prices.
The NYSE, also referred to as the “Big Board,” is the largest
and the oldest stock exchange in the United States. It has the most
stringent listing requirements. In addition to maintaining the
requirements for listing on the exchanges, companies are expected
to comply with certain regulations administered by the Securities
and Exchange Commission (SEC), such as publishing quarterly
and annual reports and releasing any information that affects the
company’s ongoing operations. Companies that do not meet the
listing requirements can be delisted. Generally, the largest, bestknown,
and most financially secure companies that meet the listing
requirements are listed on the NYSE.
When a buy or sell order is placed for a company listed on the
NYSE, the broker or registered representative transmits the order
electronically to the floor of the exchange. The order is then taken
to the trading post for that stock, where a specialist executes
the order. The ticker tape reports executed transactions. You can
watch the trades on the ticker tape, which is shown on television
networks such as CNBC during the trading session. After you
place an order to buy or sell shares, you receive a confirmation of
your executed trade from your brokerage firm.
The AMEX has less stringent listing requirements than the
NYSE and generally has the listings of younger, smaller companies.
The exchange has added the trading of stock options, stock indexes,
and exchange-traded funds (ETFs). The AMEX, like the NYSE,
has a physical trading floor, whereas the Nasdaq is an electronic
exchange. The AMEX uses a specialist system like the NYSE. A
company can be listed on the NYSE or the AMEX as well as on a
Five regional exchanges (Philadelphia, Boston, Cincinnati,
Chicago, and the Pacific Exchange) list the stocks of companies in
their geographic areas that are not large enough to qualify for listing
on the two larger exchanges. These exchanges also can dual-list
the same company. For example, General Electric is listed on the
NYSE and on several regional exchanges. The advantage of these
regional exchanges is that local brokerage firms that do not have
memberships on the NYSE have access to these dual-listed shares.
The Pacific Exchange has given up its physical trading floor and
has become an electronic communications network (ECN). An ECN is
a privately owned trading network that matches investors’ buy
and sell orders electronically. The Pacific Exchange accounts for a
large percentage of the options traded. The Philadelphia Exchange
trades in options, stock, bond, and currency indexes. If trades are
not transacted on the NYSE or the AMEX, they can be routed to the
regional exchanges in order to get better prices.
Anumber of companies that issue stocks to the public may not
be listed on any of the exchanges described in this section for a
variety of reasons. Rather, they are traded over-the-counter. The
OTC market is linked by a network of computers and telephones
and can include stocks listed on the NYSE or the AMEX. The most
actively traded issues are listed on the Nasdaq. The least actively
traded issues that do not meet the listing requirements trade on the
OTC Bulletin Board. These thinly traded stocks tend to be those of
companies that may be more speculative with regard to their future
survival. Astockbroker can provide the bid and ask prices for these
bulletin board stocks by entering a company’s code into the Nasdaq
computer system. Many large, reputable companies, such as Intel,
Microsoft, Cisco, and Dell, have chosen to remain on the OTC market
rather than move up to the AMEX or the NYSE. The listing fees
are lower on the OTC market, which is another reason why a
majority of the companies listed there are small-cap companies.
In the OTC, orders are executed differently from the way they
are executed on the exchange floor. A customer’s order to buy is
sent to the trading desk of the brokerage firm. From there, a trader
at the brokerage firm contacts market makers (in the case of an
OTC stock) or dealers (for a stock exchange–listed stock) in that
stock to determine the lowest ask price. Market makers are the firms
that buy stocks for or sell stocks from their own inventories. A
markup is added to the ask price; you can determine this amount
from the stock listings in the Nasdaq National Market Issues in the
newspaper or online. Similarly, whenever a stock is sold, an
amount called a markdown is subtracted from the bid price. In OTC
trades, a brokerage firm cannot charge a commission and also act
as the market maker. The brokerage firm has to choose between
charging a commission and earning a markup or markdown.
Market makers or dealers buy and sell securities for and from their
Some structural flaws in the Nasdaq trading system encouraged
the growth of ECNs. Not a single clearinghouse for OTC
trades existed, so buy and sell orders were not always available to
interested parties. This lack of centralization led to the charging of
high spreads, which resulted in a $1 billion fine against the Nasdaq
in 1997. In 1997, the SEC allowed ECNs to display their orders on
the Nasdaq electronic trading bulletin board along with the orders
of Nasdaq market makers in a system known as level 2 quoting.
Level 2 quotes are bid and ask prices provided by all market
makers of securities carried on the Nasdaq system.
ECNs provide individual and institutional investors with
alternative trading systems. ECNs match trades (buy and sell
orders) electronically and have increased their trading volume by
lowering spreads. Trading on ECNs is advantageous for large
institutional investors who want to trade large blocks of shares.
If these institutional investors used the Nasdaq market makers
(or the exchanges), the general investing public would see their
trades, and the stock prices would change based on that knowledge.
ECNs allow these institutional investors to trade their stocks
anonymously. ECNs also allow individual investors to trade stocks
before the stock market opens for the day and after the stock
market has closed for the day.
The diversion of trades from the Nasdaq to the ECNs reduces
Nasdaq’s revenue in that it cannot resell the quotes and trade
data to brokers and investors (McNamee, 2002, p. 81). Sustained
competition between the Nasdaq and the ECNs can only produce
better prices for investors.
The NYSE acquired the ECN Archipelago in April 2005, which
allowed the NYSE to broaden its position in options and futures
markets, as well as being able to compete with the automated
transaction market for Nasdaq-listed stocks and ETFs.
Foreign stock exchanges list and trade the stocks of their
respective markets. Financial newspapers and online financial Web
sites, such as Yahoo!, quote the prices of the most actively traded
foreign companies listed on the major European, Asian, Australian,
South African, and Canadian exchanges (foreign exchanges).
Categories in Trading Mistakes
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Failure to control Risk
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Lack of Discipline
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