How Does Stock Trading Work?

"Trading Stock" doesn't mean swapping stocks like baseball cards. You don't say, "I'll give you 100 IBMs for 100 Intels." Instead, in the financial world, "trading" means buying and selling.

The inner workings of a system that handles trading a billion shares in a day can seem puzzling. Our financial markets are impressive feats of technology and efficiency.

Whether it's an order for 100 shares of Acme Kumquats or 100,000 shares of MegaCorp, traders and markets treat each order with the same attention and paperwork.

You don’t have to know all the technical details of stock buying and selling, but having a basic understanding of how markets operate is essential for investors.

Key Takeaways

  • In the stock market language, "trading" means buying and selling stocks, not swapping one stock directly for another.
  • Floor traders work at the exchange's trading area. They help match buyers and sellers for the stocks you want to trade through your broker.
  • It usually takes a few days for floor trades to fully settle.
  • Nowadays, many brokers and big traders are doing trades electronically, getting almost instant confirmation.

Two Basic Methods

Exchanges carry out trades in two main ways: on the exchange floor or through electronic systems.

Since December 2017, there's been a big effort to shift more trading to electronic networks instead of traditional trading floors. However, this shift has faced some opposition. Many markets, like Nasdaq, trade stocks using electronic systems. But for futures markets, trading happens in person on the floor of various exchanges, which is a separate discussion.

Exchange Floor Trades

The typical portrayal of the New York Stock Exchange (NYSE) floor on TV and in movies is how most people imagine the stock market. During market hours, you witness a flurry of activity with hundreds of people bustling around, shouting, using phones, looking at screens, and working on computer terminals. It seems chaotic.

As the trading day ends, the activity slows down, but it might take up to three additional trading days for a trade to finalize, depending on its type. Here's a step-by-step guide to how a basic trade happens on the NYSE.

1. You ask your broker to purchase 100 shares of Acme Kumquats at the current market price.

2. The department handling orders at your broker sends the order to its representative working on the exchange floor.

3. The floor clerk notifies a trader from the broker's firm, who then connects with another trader on the floor willing to sell 100 shares of Acme Kumquats. It's simpler because the trader knows which floor traders handle specific stocks.

4. They both agree on a price and finish the trade. Information about the transaction goes back up, and your broker contacts you with the final price. The time taken can vary—sometimes it's quick, other times longer, depending on the stock and the market. You'll get a confirmation notice by mail a few days later.

This was a basic trade example. More complicated trades and larger amounts of stocks involve a lot more detail.

Electronic Trades

In today's fast-paced world, some people wonder how long traditional systems like the NYSE can keep up with the needed service. The NYSE does only a small part of its trades electronically, unlike Nasdaq, which is entirely electronic.

Electronic markets use big computer networks to match buyers and sellers, skipping human brokers. Though it's not as glamorous as the NYSE floor, it's quick and efficient. Many big institutional traders, like pension funds and mutual funds, prefer this way of trading.

For individual investors, you can often get almost instant confirmations for your trades, which can be important. It also gives you more control in online investing, getting you closer to the market.

But you still need a broker to manage your trades because regular people don't have access to electronic markets. Your broker uses the exchange network, finding buyers or sellers based on your order. Nowadays, it's easy to make trades through an app-based broker on your Android or iPhone.

What does this mean for you? If everything goes smoothly, you won't see much of this process. But if something goes wrong, it's good to have an idea of what's happening behind the scenes.

What Else You Need to Know

If you want to handle your investments and make your trading choices, it's crucial to understand how stock prices work, read stock quotes, grasp bid & ask prices, and know about stock orders. Learning about trailing stops is important too; they help safeguard stock profits and prevent losing all your gains.

It's also essential to know how to avoid common mistakes, like buying stocks when they're expensive and selling them when they're cheap. Avoiding investment scams is another key aspect to learn about.

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