Have you seen those images inside trading offices like the New York Stock Exchange? People jumping around, looking at the screens, waving, screaming on the phone, and monitors showing a bunch of numbers and graphs. Do you want to know few basics of stocks and how a trading system works? If your answer is yes and you're eager to jump into trading systems, then keep reading and you'll learn some basic understanding on what is a stock market, and how a trading system works from a high level perspective.
Let's start with some basics, we need to know who are the stakeholders on a trading environment. There's a financial instrument, a buyer, a seller and a place where the exchange takes place.
There are different kinds of investments that an individual, company or a financial institution can make, for this post we will focus on Stocks. The buyer and seller could be an individual, a company, or a financial institution.
Stock is a share in the ownership of a company, stocks represent a claim on the company's assets and earnings, so the more shares you acquire from a company the more ownership you get. Shares, stocks and equity all mean the same. There are different kinds of stocks, preferred stocks and common stocks, the major difference between them is the voting right. Voting right? Common stockholders can vote to elect the board members, while Preferred stock holders do not vote. Hey! That's not fair! Well... if the invested company goes to bankrupt and liquidates, the common holders will not receive money until preferred shareholders get paid...OK that's fair.
The majority of the stocks are traded on exchanges, which are places where the buyer and the seller decide on the price. The NYSE (New York Stock Exchange) is a marketplace that has a physical location where traders wave at each other, make phone calls and interacts with the trading systems. Another market place is NASDAQ, which is composed by a network of computers and doesn't have a physical location.
So how does the trading system work? Let's see the example of an investor buying 100 shares from NIKE company. In order for a trading system to identify a company share, a symbol needs to be assign to the company share, for this case: NKE is the symbol.
It all starts with the investor placing the other thru an intermediary, on this case the investor went to Bank X which has investment services, a trader from Bank X will place the order of 100 shares on behalf of his client.
The order will be processed on the Trading System of Bank X. First the bank needs to send the order for execution, meaning that the order needs to be filled with 100 shares, bought directly by the Bank, to do this an execution system communicates with the market place to get the shares. Once the Bank X has the shares, the investor and the bank agree on the price. Once the price is set, the investor and bank accounts need to be settled. Finally the transactions are tracked on the back end. The high level process is showed on the following image:
All transactions made by the bank are highly supervised by the Security Exchange Commission (SEC), which mission is to protect the investors; maintain fair, orderly, and efficient markets; and facilitate capital information. The SEC strives to promote a market environment that is worthy of the public's trust.
Is there a limit price when placing an order? NYSE is the only market? Which are the most commonly used Trading Systems? Stay tuned for the next entry...