Iordachi Victoria, dr., conf. univ.

- Tranzacii bursiere, curs de lecii

2013

THEME 2. SPOT STOCK EXCHANGE TRANSACTIONS WITH PRIMARY FINANCIAL INSTRUMENTS (4/4hs)

2.1. Organization of spot transactions on different stock exchanges Organizational forms of stock exchange trading, usually, depend on the general standing of securities market, especially on:

Market depth (the bigger is the number of investors, the deeper is the secondary market); Market size (the higher is the supply and demand of securities, the more extended is the stock exchange market);

Resistance level (has a direct connection with price range according to which market participants can buy or sell securities).

If market conditions are changed, a rupture between supply and demand is produced and prices are influenced by other different factors. Inte rnational stock exchanges have common features according to:

Designation of stock exchange components : official market from France and Germany; secondary market and over the counter markets in other European countries. In USA Stock exchange market, OTC market, the third and the fourth market; In Japan stock exchange market;

Negotiation object : domestic securities are traded on official market (national securities market in Great Britain); primary securities are traded on OTC market (international securities market in Great Britain).

According to their nature, stock exchange markets 1 are divided into two categories: auction and negotiation markets. Stock exchanges according to their nature represent auction markets , i.e. the place of concentrating buy and sell orders and insuring the market liquidity by the stock exchange brokers market agents, who act as assets intermediaries. That is why the stock exchange is also called the intermediary market , or the agency market .

A stock exchange is a mutual organization which provides trading facilities for stock brokers

and traders to trade shares and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. 1

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2013

The over the counter markets (OTC) are negotiation markets , where the confrontation between demand and supply and market liquidity insurance is done through competition of dealers who hold the market market makers; that is why these markets are called the dealer markets, as for example, the NASDAQ system from USA. Other countries present different models of stock exchanges, as combination of these two models (stock exchanges from Zurich, Vienna). Textbox 2.1.1 represents the main differences between o ver the counter and exchange trading.

Textbox 2.1.1 Difference of trading mechanis m on stock exchange and OTC markets Over the counter trading is trading that is directly between two parties. Exchange trading is trading that is done through trading facilities known as exchanges. When trading via exchanges, contracts may change hands many times before final delivery of goods. Buyers and sellers usually will never meet each other. The exchange may not even connect buyers and sellers until delivery time. An over the counter trade, however, is directly between a buyer and seller. Over the counter trades have high counter party risk, risk that the other party will not be able to deliver their part of the contract. Exchanges, on the other hand, virtually eliminate this risk by requiring traders to post margins and by closing out positions daily. Exchanges also make rules about trading and standardize contracts.

According to way of SE functioning, three types of transaction systems can exist: 1. Call markets market in which each transaction takes place at predetermined intervals and where all buy and sell orders are aggregated and transacted at once. The exchange determines the market clearing price based on the number of buy and sale orders. In a call market, the price is set by the exchange so the market will clear, or almost clear, every time orders are filled. This is in stark contrast to the auction market, where prices are determined by buyers and sellers. The assets negotiation is done through open outcry: the market is cried and stock exchange agents directly contract verbally. Some stock exchanges use the procedure of written auction. For example, small stock exchanges from Austria, Belgium, Israel. Because the call market groups transactions together, there is a substantial increase in liquidity. Although liquidity is generally considered to be a good quality in any marketplace, sellers may lose some of the liquidity premium, which is can be substantial.

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The function of orders collection, their centralized presentation on the market, negotiations realization and contracts conclusion of stock exchange is exercised by the market agents. The negotiation between brokers is done under the coordination of stock exchange officer (Chief of auction), whose task is to control the establishment of a representative price, which insures the equilibrium at the respective moment between the supply and demand on the market. It is followed the determination of the price, which will insure the highest quantity of transactions. For this, the auctions leader announces the prices proposals, according to which market agents get to know buy put and bid offers; when the bid outcries exceed in volume the put outcries, the price increases, and vice-versareduced, until a rate of market equilibration is created. So, call markets create a unique price at each outcry called the official price of stock exchange and all transactions are concluded at the respective price. For each assets, the contracts conclusion is done in a limited time interval after outcry, then another a sset s outcry begins and its contracts conclusion follows, and so on. So, the market functions according to successive steps, and not continuously. The main advantage of the system is that it is fixed the market equilibrium price. 2. A call market is contrasted to continuous markets (auction markets), where orders are filled as soon as a buyer/seller is found for any given order at an agreed upon price (See Textbox 2.1.2). Textbox 2.1.2 Auction market representative example Auction market - a market in which buyers enter competitive bids and sellers enter competitive offers at the same time. The price a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell at. Matching bids and offers are then paired together and the orders are executed. Auction markets differ from over the counter where trades are negotiated. The New York Stock Exchange (NYSE) is an example of an auction market. For example, 4 buyers want to buy a share of XYZ and make the following bids: $10.00, 10.02, 10.03 and $10.06. Conversely, there are 4 sellers that desire to sell XYZ and they submitted offers to sell their shares at the following prices: $10.06, 10.09, 10.12 and $10.13. In this scenario, the individuals that made bids/offers for XYZ at $10.06 will have their orders executed. All remaining orders will not immediately be executed and the current price of XYZ will then be $10.06.

Iordachi Victoria, dr., conf. univ. - Tranzacii bursiere, curs de lecii

2013

Continuous markets - a stock market or exchange where securities are continuously priced and traded in an auction format when the market is open . It is a securities market in which trades may be made at any time without affecting the market price because there is a sufficiently high level of trading. In case of continuous markets, o rders collection at stock exchanges is done through stock exchange societies, and the high market volume, assets dissemination by investors, as well as the activity of strong financial societies insure both the liquidity, and the continuity of the market (for example, Tokyo Stock Exchange). In most case, irrespective the OTC or stock exchange the key role is played by the market maker. He takes the position on assets with which he performs, i.e. becomes another part within the transaction with the clients of the SE; the seller for the buyers and the buyer for sellers. Any market maker presents two prices: the bid price (of purchasing), the lowest price a company can afford for the assets purchase; the ask price (of selling), the highest price the company asks for assets purchase. Always, the ask price is higher than the bid price, the difference the spread, representing the market makers profit. In such a way, the transactions are not concluded at an unique price, but at prices which are always changing during the stock exchange session according to supply and demand of assets at each moment. In this case the stock exchange will not publish an official rate, but more rates: open price, maximal, minimal price and closing rate. 3. Mixed stock exchanges are transaction systems, which combine at the same time or successively, outcry or continuous procedure. Organization of stock exchange transactions on different stock exchanges depends on:

Type of auction practiced by stock exchanges in different countries; Stock exchange intermediaries.

There are known diffe rent systems of auctions: Ordinary auctions before the beginning of auction the sellers submit their ask (sale) offers at the initial proposed price and if competition exists among buyers, the given price rises step by step (the step size is fixed before the beginning of auction), until one single buyer remains and securities are sold at the highest offered price. Dutch auction the initial sellers price is high and the person engaged in auct ion organization consequently proposes lower prices, until the unique one is accepted. In this case securities are sold to the first buyer, to whom the offered price is convenient. Random auction (the unseen auction), or no-frequency auction all buyers submit simultaneously prices and securities get into the possession to the one who offered a better price.

Iordachi Victoria, dr., conf. univ. - Tranzacii bursiere, curs de lecii

2. 2. Mechanism of pe rforming a SPOT transaction at stock exchange

2013

SPOT transactions represent operations by means of which the seller-buyer is responsible to deliver sold securities or amount of money that represent transaction value in not more that 48 hours. The buye r is responsible to pun on account opened at brokerage company securities countervalue, while the seller is responsible to put on account opened at brokerage company all securities proposed for selling. An effective mechanism of SPOT transaction realization at stock exchange supposes the following stages: Initiation the establishment of connection between the client and stock exchange (broker); the client gives an order to the broker to buy or sell securities; Conclusion the contracts conclusion and negotiation by the SE agents; Execution of the contract performance of obligations and obtaining the right from transaction. Schematically, the mechanism of stock exchange transaction is represented in Figure 2.2.1.

Brokerage company Transaction department A2

B3

Brokerage company Stock Exchange B2 B4

C2 A2 A3 B3

B1

B1

Transaction department A2

C2 A3 A1

Clearing house C1, C3 Client buyer Client seller

Figure 2.2.1. The mechanism of stock exchange transaction A1 initiation of stock exchange transaction by seller/buyer A2 opening account for those two clients; A3 placing orders by clients to brokers; B1 sending orders by brokers to borkerage companies, or brokers inside the stock exchange; B2 price creation for the asset that is object of transaction; B3 orders execution at stock exchange or contracts conclusion; 5

Iordachi Victoria, dr., conf. univ. - Tranzacii bursiere, curs de lecii

2013

B4 notification of completion of contracts notificarea (transfer of rights and responsibilities on stock exchange product); C1 transfer of assets from the account of selllers brokerage company to the account of buyers brokerage company; C2 notification of assets transfer ; C3 payment of assets price through debiting the buyers account and payment acceptance through crediting the sellers account.

1) Initiation: In order to perform a transaction with securities at any stock exchange, the seller or the buyer should contact a stock exchange agent. Choosing the broker, who is a stock exchange member has a lot of advantages for the client, as the member quality insures seriousness and professionalism. In case of an independent broker, the client will contact him by phone or personally in order to give the order to buy or sell and the broker will transmit the order to inside brokers of stock exchange. 1. The first phase of the process of transactions initiation is opening an account by broker for his client, the account can be either cash account or cheque account. But for stock exchange transactions the margin account is more appropriated, which allows an automatic credit on behalf of broker. For each transaction, the broker charges a commission (which is added at the bid price (of purchasing) and which is taken from the ask price (of selling). In case of credits granting within the margin account, the broker also charges interest. 2. The second phase is the orders placing by the client , by means of personal connection or by telephone with the broker. A SE order is a firm offer (in case of selling), or a command (in case of purchasing) of a certain quantity of securities in special terms. The elements of a stock exchange orde r are: the operations direction (purchase/sale stock exchange product quantity offered/commanded type of transaction (cash, futures operation) maturity (in case of futures transactions) price (the rate). Investors have several options when it comes to plac ing an order to buy or sell securities. For example, whether you place an order directly with your broker or trade online, you can instruct your broker to buy or sell at a specified price. Or you can place an order that is good for one day only or for an extended period.

Iordachi Victoria, dr., conf. univ. - Tranzacii bursiere, curs de lecii

2013

Understanding how different types of orders work may make a difference in whether your trade gets executed and at what price. So, depending on price specified by the client, there are: a) common orders: - Market order is an order to buy or sell a stock at the current market price. Unless the client specifies otherwise, his broker will enter the order as a market order. The advantage of a market order is the client is almost always guaranteed his order will be executed (as long as there are willing buyers and sellers). Depending on the firms commission structure, a market order may also be less expensive than other types of orders ( for example, limit order). The disadvantage is that the price that is paid when the order is executed may not always be the price that will be obtained from a real-time quote service. This may be especially true in fast- moving markets where stock prices are more volatile. When the client places an order "at the market," particularly for a large number of shares, there is a greater chance he will receive different prices for parts of the order. To avoid buying or selling a stock at a price higher or lower than you wanted, you need to place a limit order rather than a market order. There are two types of market orders:

A buy market order stipulates execution of the contract at the lowest possible price existent at the stock exchange by the broker from the moment when he receives such an instruction; A sell market order should be executed at the highest possible price existent at the stock exchange from the moment the broker receives such an instruction.

- A limit order is an order to buy or sell a security at a specific price. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. When it is placed a market order, the client can't control the price at which his order will be filled.

Example of a limit order: if you want to buy the stock of a "hot" IPO that was initially offered at $9, but don't want to end up paying more than $20 for the stock, you can place a limit order to buy the stock at any price up to $20. By entering a limit order rather than a market order, you will not be caught buying the stock at $90 and then suffering immediate losses if the stock drops later in the day or the weeks ahead.

The advantage of limit order is that by using a limit order the client protects himself from buying the stock at a too high price.

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2013

At the same time, the disadvantage of limit order: the order may never be executed because the market price may quickly surpass the limit before the clients order can be filled. Some firms may charge their clients more for executing a limit order than a market order 2 . b) conditional orders: A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, the stop order becomes a market order. Buy Stop Order investors typically use a stop order when buying stock to limit a loss or protect a profit on short sales. The order is entered at a stop price that is always above the current market price. Sell Stop Order A sell stop order helps investors to avoid further losses or to protect a profit that exists if a stock price continues to drop. A stop order to sell is always placed below the current market price. The advantage of a stop order is the client does not have to monitor how a stock is performing on a daily basis. The disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price. Also, once the stop price is reached, the stop order becomes a market order and the price that is received may be much different from the stop price, especially in a fast- moving market where stock prices can change rapidly. An investor can avoid the risk of a stop order not guaranteeing a specific price by placing a stop- limit order. The use of stop orders is much more frequent for stocks that trade on an exchange than in the overcounter (OTC) market. In addition, some broker-dealers may not allow their clients to place a stop order on some securities or accept a stop order for OTC stocks. A stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order. Once the stop price is reached, the stop- limit order becomes a limit order to buy or to sell at a specified price. The benefit of a stop-limit order is that the investor can control the price at which the trade will get executed. But, as with all limit orders, a stop-limit order may never get filled if the stock's price never reaches the specified limit price. This may happen especially in fast- moving markets where prices fluctuate wildly. The use of stop limit orders is much more frequent for stocks that trade on an exchange than in the over-counter (OTC) market. In addition, your broker-dealer may not allow you to place a stop limit order on some securities or accept a stop limit order for OTC stocks. Before you enter into this type of order, you should speak to your broker or financial advisor about how the order works. c) Time restriction orders:

A limit order is always associated with at a better price clause, meaning: if the broker can buy securities at a lower price or can sell them at a higher price, he is obliged to do it immediately. On the contrary, he is responsible for market loss. 8

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- Day order - Unless you give your broker specific instructions to the contrary, orders to buy or sell a stock are "day orders," meaning they are good only during that trading day. Orders that have been placed but not executed during regular trading hours will not automatically carry over into after-hours trading or the next regular trading day. Similarly, day orders placed during after-hours trading can only be executed during that after-hours session. If your order is not executed during a trading session, you will have to place a new order in the next trading session. - a good-til-cancelled (GTC) order - is an order to buy or sell a security at a specific or limit price that lasts until the order is completed or cancelled. A GTC order will not be executed until the limit price has been reached, regardless of how many days or weeks it might take. Investors often use GTC orders to set a limit price that is far away from the current market price. Some brokerage firms may limit the time a GTC order can remain in effect and may charge more for executing this type of order. - a fill or kill orde r (FOK) - An order given to a broker that must immediately be filled in its entirety or, if this is not possible, totally cancelled. d) special execution terms orders: - all or none order - a stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were fill or kill. - at the opening order - an order to buy or sell a given equity at the price when the market opens). If the transaction cannot occur at this price, the order is cancelled. - at the close order - an order specifying that a trade is to be executed at the close of the market, or as near to the closing price as possible (usually last 30 seconds). During the SE orders execution, one of the main obligations of the brokers is to respect the priority rules. The priority price means that SE agents should execute bid orders at higher prices before the ones rate dat lower prices, and the ask orders at lower prices before the ones rate dat higher prices. 2) Ways of negotiation: The contracts conclusion, or the execution of stock exchange orders is done in different ways on different stock exchanges, according to the system of transactions, as well as to the specific procedure of each SE, according to internal regulation. In international practice, several ways of negotiation procedures are known: Negotiation in base of order book totalizing all received orders by brokers in an order book; the order book includes orders distributed according to their degree of negotiability (bid orders at the highest price lowest price and put orders at the lowest price highest price). The order book can be consulted by third stock exchange agents, or it can be closed, as only the price and volume of best quoting are listed at stock exchange. 9

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Negotiation in base of a table inscription presenting orders in such a way as all of them could be seen by stock exchange agents during the session. This procedure is done electronically, or by chalk writing of first two bid and put prices (the best ones). The negotiation is done when the third SE agent accepts a quotation listed on the table. Negotiation by trading in the ring (public announcement of orders) each asset is distributed for trading at one of the existing rings (ex. stock exchange of Budapest, Zurich). Negotiations are opened by a stock exchange officer who cries the assets that results to be negotiated. Than stock exchange agents loudly announce the price (ask and bid) and search for interested partners (The example of using trading in the ring is given in Annex 2.2.1).
Negotiation by pit trading is a model of trading in the ring. The pit is a semicircular space, very agglomerated, where stock exchange agents outcry their bid/ask prices. It is practiced in case of futures and options contracts and other financial assets that suppose a high degree of trading at SE. (The example of using

trading in the ring is given in Annex 2.2.2).

Negotiation trades or block trading takes place outside the main negotiation room of the stock exchange , but in a special room of a SE. A large amount of securities being traded, typically at least 10,000 shares of stock or $200,000 in bonds. Normally, only institutional investors undertake such large trades. Block trades can affect the market price of the security, depending on the liquidity of the market. Block trading can be done through:

- Exchange distribution - a type of trade made on the floor of a securities exchange in which a large block of shares traded actually represents many b uy and sell orders that have been pooled and executed as one transaction. Exchange distributions are recorded on the ticker tape3 after the trade has taken place. - Secondary distribution - a registered offering of a large block of a security which has been previously issued to the public, by a current shareholder. The proceeds of the sale go to the holder, not the issuing company, and the number of shares outstanding does not change. - Exchange aquisition (achizitie in bursa) supposes purchasing some blocks of assets. - Electronic trading for detail information see Textbox 2.2.1 from Annex 2.2.3. 3) Contracts execution when two orders (bid/ask orders) meet with terms of maturity, volume, and price at stock exchange the contracts conc lusion takes place. This results in the realization of the contractors duties, to pay for assets and to deliver the necessary quantity of assets. The process through which these obligations are executed is called the contracts execution or the transactions liquidation. There are known two systems of contracts execution at stock exchange:

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by direct liquidation by centralized liquidation (clearing).

A computerized device that relays financial information to investors around the world, including the stock symbol, the

latest price and the volume on securities as they are traded.

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Iordachi Victoria, dr., conf. univ. - Tranzacii bursiere, curs de lecii

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Direct liquidation (cash and carry) was especially used during the first stages of the stock exchange activity; it supposes the delivery of assets from stock exchange company that sold assets to the stock exchange company that purchase assets, and a vice-versa transfer of value 4 . The liquidation mechanism implies the following main phases: a) Comparison of documents over the contract: the sellers broker contacts the buyers broker to check the terms for the contracts conclusion; b) Assets delivery by means of a courier, usually the second day in the morning; c) When the courier submits the assets, the buyers broker issues a cheque. Centralized liquidation (by means of clearing) sales made at stock exchange are compensated through purchases, so at the end of the day only the balances are regulated. It supposes the intervention of two specialized institutions: deposit house, which functions as central depository for all assets held by its members, the participants of stock exchange, and the clearing house, which makes compensations and determines the credit/debit balances of its members related to assets and value. The deposit house is the institution that keeps in a centralized way all assets of its members ; depositing can be done either for materialized assets, or for non- materialized assets (book entry). The reason of creating this institution is to rationalize the process of keeping and delivering assets, insuring their security and operative circulation. The clearing house is an important constituent of a stock exchange. Every stock exchange maintains a clearing house for the settlement of transactions in cleared securities. The stock exchange authorities announce the clearing days every month. The members of the stock exchange are usually the members of the clearing house. They are required to maintain deposits with the clearing house. The clearing house is operated in accordance with the rules and regulations of the exchange. Every member is required to submit a statement of the contracts made by him. A day before the clearing date, every seller is required to deliver the share certificates and the transfer deeds to the clearing house. A clearing house is very useful to the members of the stock exchange. They are saved from the trouble of making and receiving payments in respect of several transactions. They can receive or pay only the net dues through the clearing house. Thus, the settlement of transactions becomes prompt and easy. Usually, the clearing house is a commercial society (corporation, in USA), or a non-profitable institution (Japan), created by association stock exchange members, or other banking and financial institutions. The members of clearing house make a capital contribution at the creation of clearing fund, which is the institutions financial basis, and has the following functions: to guarantee obligations assumed by clearing house and to distribute risks referring to stock exchange transactions performed by
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Nowadays this way of contracts execution is not efficient and thus is not performed. 11

Iordachi Victoria, dr., conf. univ. - Tranzacii bursiere, curs de lecii

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members. If a member cannot honour his obligation of delivery/payment, its debt is covered by his contribution to the clearing fund, this stake to the fund should be completed by the brokerage companymember of the clearing house in short time. Clearing of assets can be performed through: a) Traditional procedure of delivery/reception of assets. The clearing house gives an order to the institution that keeps assets (deposit house) to delive r assets. This process of assets transfer supposes the performance of formalities regarding the registration of the new assets owner. b) Through book entry, regulation in base of electronic account. In this case the depository of assets is in form of an account registration, while the transfer of assets supposes account crediting/debiting. The mechanism of trading through clearing system is represented in Figure 2.2.2.

Client

Clearing house Assets transfer from the account of company A to the account of company B (5)

Client

1a 6

1b

2a

2b

SE company A
7a

SE (3)
7b

SE company B

Figure 2.2.2. Mechanis m of stock exchange transaction through clearing system Where: 1 order to sell (a) to buy (b); 2 - order to sell (a) to buy (b); 3 transactions conclusion; 4 notification of the contracts conclusion; transfer of rights and obligations on assets; 5 assets transfer from the account of comp. A to the acco unt of comp. B; 6 notification regarding the transfer of assets; 7 crediting (a), debiting (b) the clients account.

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The intervention of deposit house and clearing house within the process of stock exchange transactions simplifies the liquidation procedure and increases operativeness, clients confidence and interest for further engagement in multiple transactions.

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Annex 2.2.1

London Metal Stock Exchange: trading in the ring

Ring trading is so called because the LME uses a "ring" with the traders sitting at fixed points around the circle. Trading takes place throughout the day with each LME contract traded in specific five minute periods known as "rings". The LME system of fixed points clearly helps with the identification of the firms trading, but it is only feasible because the Exchange has a small number of members permitted to take part in ring trading. At present there are 12 ring dealers, and all business which is required to be dealt across the floor must be passed through a ring dealing member. A significant proportion of all LME contracts are traded in the ring sessions, including the kerb, or as a result of that trading. The balance goes through the inter-office telephone market and LME select. The ring sessions, and especially the second morning rings from which official prices emerge, concentrate liquidity because the physical trade requires prices as close as possible to the daily and monthly settlement prices. This concentration of liquidity Annex ensures 2.2.2 both transparency of pricing, and more representative prices than may be obtained through inter-office trading. The ring itself is about 6m in diameter, with two large display boards above it showing the official prices. There is a special booth where the Exchanges staff monitor the prices and input bids, offers, spreads and trades made into a computer system. This is instantly sent to the various news vendor services, who display LME prices. Behind each firms ring seat is a place for assistants to stand in order to pass orders into the ring and to give commentaries to customers about current market conditions.

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Annex 2.2.2

Pit trading vers us electronic trading

Pit trad ing and electronic trading are the two major methods of trading used by traders trading financial products. Pit trading also known as floor trad ing is the trading of stocks or futures manually in the exchange floor, known as Pit. It was the main type of trading until late 1990s. But the introduction o f electronic trading of stock and futures have certainly lowered the popularity of pit t rading and now more and more pit traders are moving to electronic type. Electronic or online trad ing of stock and futures holds much more advantages than pit trading as , No need of extensive physical strain. Faster order entry and execution. Ability to trade a nu mber of exchanges. Choice of order routing destination. Ability to trade mu ltiple products simu ltaneously. Instant market data as charts and instant news. Access to advanced trading programs integrated with powerful analyzing tools. Speedy access to account details. Even broker independent trades. But still floor trad ing is practiced quiet extensively and in some markets like S&P, the pit trading volume is much larger than the electronic trading volu me. So me exchanges and investment firms are looking to build much larger trad ing floors. Today, electronic pit trad ing is also available in some markets.

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Annex 2.2.3

Textbox 2.2.1. Peculiarities of trading on the exchange floor and by electronic devises To trade means to buy and sell in the jargon of the financial markets. How a system that can accommodate one billion shares trading in a single day works is a mystery to most people. No doubt, our financial markets are marvels of technological efficiency. There are two basic ways exchanges execute a trade: On the exchange floor; Electronically. There is a strong push to move more trading to the networks and off the trading floors, however this push is meeting with some resistance. Trading on the floor of the New York Stock Exchange (the NYSE) is the image most people have thanks to television and the movies of how the market works. When the market is open, you see hundreds of people rushing about shouting and gesturing to one another, talking on phones, watching monitors, and entering data into terminals. It could not look any more chaotic. Yet, at the end of the day, the markets workout all the trades and get ready for the next day. Here is a step-by-step walk through the execution of a simple trade on the NYSE. You tell your broker to buy 100 shares of Acme Kumquats at market. Your brokers order department sends the order to the ir floor clerk on the exchange. The floor clerk alerts one of the firms floor traders who finds another floor trader willing to sell 100 shares of Acme Kumquats. This is easier than is sounds, because the floor trader knows which floor traders make markets in particular stocks. The two agree on a price and complete the deal. The notification process goes back up the line and your broker calls you back with the final price. The process may take a few minutes or longer depending on the stock and the market. A few days later, you will receive the confirmation notice in the mail. Of course, this example was a simple trade, complex trades and large blocks of stocks involve considerable more detail. In this fast moving world, some are wondering how long a human-based system like the NYSE can continue to provide the level of service necessary. The NYSE handles a small percentage of its volume electronically, while the rival NASDAQ is completely electronic. The electronic markets use vast computer networks to match buyers and sellers, rather than human brokers. While this system lacks the romantic and exciting images of the NYSE floor, it is efficient and fast. Many large institutional traders, such as pension funds, mutual funds, and so forth, prefer this method of trading. For the individual investor, you frequently can get almost instant confirmations on your trades, if that is important to you. It also facilitates further control of online investing by putting you one step closer to the market. You still need a broker to handle your trades individuals dont have access to the electronic markets. Your broker accesses the exchange network and the system finds a buyer or seller depending on your order.

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