Trading Securities

by Jules Peters Online Trader

An article coming as a sequel of my previous post here.
Auction markets
Trading may take place in markets where prices are continually quoted in ‘one place’ either physically at a specific geographic location (e.g. NYSE) or electronically (e.g. Archipelago in the US). In some auction markets, notably the NYSE and the futures and option markets in Chicago, trading takes place face to face in a ‘pit’. Physical auction markets often also have platforms that allow electronic trading. Challenges to traditional markets have appeared from dealing systems on the Internet such as Charles Schwab and E*Trade. There is also competition between order-driven dealing systems (i.e. where buyers and sellers are matched electronically), which predominate in a number of European centres, and the NYSE and NASDAQ, which have quote-driven systems (i.e. market makers/dealers quote firm bid and ask prices for particular sizes of trades).
NASDAQ
This consists of a large number of broker-dealers and is an OTC market in stocks of ‘small’ companies. Many (but not all) of these ‘small’ stocks are quoted on the National Association of Security Dealers Automated Quotation System. There are various levels of membership of NASDAQ depending on whether you wish to act as a market maker/dealer, or just a broker or just receive information on inside quotes. Most trades are now undertaken on electronic trading platforms - you can find more about the trading platforms online and brokers at CashBackBinaryOptions.
London stock exchange
In London shares are traded on the quote-driven SEAQ (Stock Exchange Automated Quotations) and these tend to be larger trades. On SEAQ the touch is the difference between the highest bid and lowest offer price and on SEAQ these are displayed in a ‘yellow strip’ on the screen. But there is also an order-driven system (SETS, Stock Exchange Electronic Trading Service), which also incorporates an electronic clearing system. Most trading is now via SETS. Any buy or sell orders that can be crossed are executed automatically. Stocks of smaller companies are traded on the Alternative Investment Market, AIM.
Market makers (dealers)
Market makers (or dealers) hold an inventory of securities that they stand ready to buy or sell at quoted prices - this is known as a book. Most dealers are located in large investment banks. A dealers will execute trades on her own behalf and also for ‘clients’ (usually brokers). Ordinary investors who approach a market maker (probably via their broker) are on the ‘other side of the trade’ and therefore they buy (from the dealer) at the ask price and sell (to the dealer) at the bid price. The difference between the two prices is the bid-ask spread. The bid-ask spread allows dealers to make a profit, as they buy securities at a lower price than they sell them. If a market is highly competitive, the bid-ask spread will be reduced to a level that just allows dealers to make a profit. Price quotes differ between dealers. On electronic trading screens the bid and ask prices (and the quantities they are willing to trade at these prices) from all the dealers are presented in a list. At the top of the list are the best bid and ask prices from the dealers. So for buy orders from all dealers the best bid price might be $95. For sell orders the best ask price from among all dealers might be $95.05. These ‘best’ prices are known as the inside quotes and here the inside spread is 5 cents. However, the inside quote will usually be valid only for a small trade (e.g. 5000 shares) and if you wish to trade a larger lot, you will have to search through the quotes to get the best deal (which might involve splitting your trade between different dealers). The tick size is the minimum price movement allowed on a particular security. For example, the tick size for government bonds in the US is 1/32 of 1% (of the par value). The tick value represents the cash value of 1 tick. Clearly, this depends on the size of the deal being quoted. For example, on $100,000 held in government bonds, the tick value is 31.25[=$100,000(1/3200)].
Changes in interest rates are generally discussed in terms of basis points. A rise in interest rates from 5% to 6% is a change of 100 basis points (bp), hence 1 bp is equivalent to 0.01%. Different markets (e.g. for FX, futures and options) have different tick sizes and tick values. These concepts provide a useful shorthand for market participants who might, for example, state that ‘bond yields are up by 10 basis points’.
Brokers
Whereas dealers trade on their ‘own account’ and hold positions in various securities, a broker acts as a middleman between two investors (usually referred to as counterparties. The broker brings the buyer and seller together (e.g. this could be two different dealers or a private or institutional investor and a dealer). The broker does not hold a ‘book’ but charges a commission for transacting the deal between the two counterparties. Sometimes the broker will consolidate the commission in the bid-ask spread. Most large banks provide both a brokerage service and have dealers who run a book. There are full-service brokers and discount brokers (e.g. Charles Schwab, E*Trade). Both types of broker execute orders including short sales) often over the Internet, they also hold securities for safekeeping (in ‘street name’) and provide margin loans. In addition, full-service brokers provide research services and investment advice