The Nasdaq is a computer-based stock exchange where buyers and sellers meet electronically. Even though computers keep track of all the orders, there is still a very human presence in the Nasdaq and that is the market maker.
Unlike the New York Stock Exchange and some other smaller exchanges, there is no physical Nasdaq trading floor.
However, that’s not the only difference between the Nasdaq and the NYSE. The other major difference is that the NYSE is an auction market where orders set the prices. A specialist in each stock determines the price based on the orders.
The Nasdaq, on the other hand is a negotiated market where the computer network posts prices from different buyers and sellers. The best prices get filled first. If you want to sell your stock, you’ll need to post the best price.
The Market Maker The market maker is an investment company that registers with the SEC to buy and sell a particular stock on the Nasdaq.
Unlike their counterparts at the NYSE, the market makers work through a computer network rather than on the floor of a physical exchange.
Their job is, literally, to make a market in a particular security. Here is what they do:
They fill orders for their company’s customers and for their own account
They also act as dealers to profit from the difference between the bid and ask price for the stock The Nasdaq requires market markers to provide a “two-sided quote” in the securities they cover.
Buy and Sell This means they must post a price they will buy at and a price they will sell at (a bid and ask price – see my article on “bid and ask” prices for more information). These prices along with customer orders go into the Nasdaq computer system and the system ranks the orders.
The best prices to buy and the best prices to sell automatically go to the top of the queue and the computer fills them first. The difference is the computer moves orders and prices through the system faster than any human ever could.
Unless you have access to an information provider that offers Level II Nasdaq screens, you will never see this process at work. Level II screens reveal the process of ranking prices and a tremendous amount of information about orders.
Level II Screens You can buy access to Level II screens from a number of vendors; however, it could cost up to $300 per month or more depending on what options you choose.
Day traders, swing traders and others who trade on very tight margins need this type of information. Most other investors do not.
Conclusion The important thing to remember is that the market maker on the Nasdaq is responsible insuring a market is available for listed securities by posting a bid and ask price.
The Nasdaq system posts the best prices first and fills orders in this ranking. This process guarantees investors the best possible price at that moment, whether they are buying or selling. The market maker assures that there will be a market for the security; however, they don’t guarantee it will be at the price you want.
Thursday, March 13, 2008
STOCK TRADING FIRST STEP
Basic Steps in How Stock Trading Works
Trading stocks. You hear that phrase all the time, although it really is wrong – you don’t trade stocks like baseball cards (I’ll trade you 100 IBMs for 100 Intels).
Trade = Buy or Sell
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.
Yet, they still must handle your order for 100 shares of Acme Kumquats with the same care and documentation as my order of 100,000 shares of MegaCorp.
You don’t need to know all of the technical details of how you buy and sell stocks, however it is important to have a basic understanding of how the markets work. If you want to dig deeper, there are links to articles explaining the technical side of the markets.
Two Basic Methods 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. Most markets, most notably the NASDAQ, trade stocks electronically. The futures’ markets trade in person on the floor of several exchanges, but that’s a different topic.
Exchange floor
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 broker’s order department sends the order to their floor clerk on the exchange.
The floor clerk alerts one of the firm’s 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.
Electronically 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 don’t have access to the electronic markets. Your broker accesses the exchange network and the system finds a buyer or seller depending on your order.
Conclusion
What does this all mean to you? If the system works, and it does most of the time, all of this will be hidden from you, however if something goes wrong it’s important to have an idea of what’s going on behind the scenes.
Trading stocks. You hear that phrase all the time, although it really is wrong – you don’t trade stocks like baseball cards (I’ll trade you 100 IBMs for 100 Intels).
Trade = Buy or Sell
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.
Yet, they still must handle your order for 100 shares of Acme Kumquats with the same care and documentation as my order of 100,000 shares of MegaCorp.
You don’t need to know all of the technical details of how you buy and sell stocks, however it is important to have a basic understanding of how the markets work. If you want to dig deeper, there are links to articles explaining the technical side of the markets.
Two Basic Methods 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. Most markets, most notably the NASDAQ, trade stocks electronically. The futures’ markets trade in person on the floor of several exchanges, but that’s a different topic.
Exchange floor
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 broker’s order department sends the order to their floor clerk on the exchange.
The floor clerk alerts one of the firm’s 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.
Electronically 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 don’t have access to the electronic markets. Your broker accesses the exchange network and the system finds a buyer or seller depending on your order.
Conclusion
What does this all mean to you? If the system works, and it does most of the time, all of this will be hidden from you, however if something goes wrong it’s important to have an idea of what’s going on behind the scenes.
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