Buy and Sell

							                                        Buy and Sell
                                 How Securities are Traded
                                    Principles of Finance
                                       Mrs. Schroeder

Two Basic Types of Trades
 When you instruct your broker to buy or sell for you, you are placing an order
    You place a buy order when you want to purchase a stock
    Your place a sell order when you want to sell a stock that you own
 All trades, however, are not straightforward buys and sells

Several Types of Buys/Sells
 The simplest and most common type is a market order
    A market order is a buy or sell order to be executed immediately at the best available
     price
    Example:
       • Let‟s say you place a market order with your broker to sell your shares of ABC
         stock
       • Your order goes through immediately, but you cannot specify a price
       • You receive the current market price for ABC stock
       • You cannot specify a price with market buy orders, either
       • If you want to purchase ABC stock, you pay the current market price
    The appeal of market orders is their speed—investors know that their order is
     executed quickly
    Also, market orders typically have the lowest commission costs
 Another type of order is a limit order
    A limit order is a buy or sell order that specifies a price limit at which to execute the
     trade
    Example:
       • Let‟s say DEF stock is currently trading at $32 per share
       • If you place a limit buy order with your broker for DEF stock at $25, the order will
         be executed if, and only if, the price of DEF stock falls to at least $25
       • That means you will not pay more that $25 for the stock, and you may even pay
         less than that
       • On the flip side, a limit sell order will be executed only if the stock rises to a certain
         price
       • You might use a limit sell order to instruct your broker to sell your shares of DEF if
         the market price hits $40 or higher
    Investors placing limit orders need to make sure they‟re worthwhile, as limit orders:
       • Have higher commissions than market orders
       • May go unfilled if the specified price is never reached
 Like a limit order, a stop order (sometimes called a stop-loss order) instructs a broker
  to execute a trade when a certain price is reached or passed
    Unlike limit orders, however, stop orders are placed above the current market price
     for buys and below the current market price for sells
    Stop orders are often used by investors who don‟t have the time to keep a close eye
     on the market
    Example: Say you‟re very interested in buying GHI stock (currently priced at $18),
     and you‟re hoping the price will come down
       • You can instruct your broker to buy (place a stop buy order) if the price goes up to
        $20
          • You do this because you think the price will go down
          • You want to be “protected” in case the price rises
      • With a stop buy order, you set your top price for the purchase
      • Stop buy orders are used in short sales, which are not recommended for beginning
        investors
    Example: If you already own GHI, you might place a stop sell order for $16
      • Your broker will sell if the stock‟s price falls to $16
      • With a stop sell order, you set your lowest price for the sale
      • Investors use stop sell orders to limit their losses if a stock is plummeting in price

Restrictions on Orders
 If you don‟t place any restrictions on your order, it will usually be entered as a day order
    Day orders expire at the end of the trading day
    If a day order goes unfilled and you still want it executed, you‟ll have to re-enter it the
      next day
 Your options for placing restrictions on the orders are:
    All or none (AON)
       • You may place a buy order with your broker for 30 shares of JKL stock at the
         current market price
       • When your broker goes to execute the order, s/he finds out the there are only 25
         shares available to be purchased
       • Your order will be executed for those 25 shares unless you‟ve placed an all-or-none
         restriction on it
       • The AON lets your broker know that you want to purchase either the full 30 shares
         or none at all
    Good „til canceled (GTC)
       • When you place a good „til canceled restriction on your order, you‟re telling your
         broker to keep the order active until you decide to terminate it
       • Most brokers will give you a maximum length of time you can keep the order
         active, typically 90 days
       • Order with good „til canceled restrictions are:
           • Called open orders
           • Used for limit or stop orders
    Fill or kill
       • A fill or kill order is meant for immediate execution
       • If you place a fill or kill order with your broker and it cannot be executed
         immediately, it is automatically canceled
    Round lots
       • Instructs your broker to buy or sell shares in multiples of 100
    Odd lots
       • An odd lot order instructs your broker to buy or sell fewer than 100 shares
       • Thanks to computer technology, odd lots and even fractured shares are now
         commonplace

Securities Exchanges
 After securities have been issued to the public through an IPO (initial public offering),
  investors are free to trade the securities among themselves
 Doing so is know as trading on the secondary market
 The secondary market is composed of:
    Securities exchanges
      • An exchange is a place where securities are bought and sold, such as the New
        York Stock Exchange (NYSE)
      • It provides a place (either physical or virtual) for the securities to be traded, as
        well as rules and regulations to give a framework to the trading process
      • The exchange itself does not set the price of a securitythat is the result of supply
        and demand
      • Trading on the floor of a typical exchange takes place in what‟s called “auction
        style”
      • This means that securities are traded when the lowest offer to sell meets the
        highest bid to buy
    Over-the counter market
      • The over-the-counter (OTC) market is not a formal securities exchange, and,
        therefore, the membership and listing requirements are not as stringent as they
        are on the NYSE, for example
          • The computer-linked network for trading OTC securities is called the NASDAQ
          • Thousands of brokers are registered dealers on the NASDAQ
          • Other brokers can execute trades by contacting these dealers, who have listed
            their quotes on the NASDAQ computer network
      • There are three levels of NASDAQ subscribers
          • The highest level is reserved for investment firms dealing in OTC securities
              • They are known as market makers
              • Market makers are responsible for individual stocks, maintaining an
                inventory in them by buying them from and selling them to the public
          • The middle level is for subscribers who receive all listed quotes but cannot
            enter their ownthese subscribers are usually brokerage firms making trades
            for clients but not actively dealing for their own accounts.
          • The lowest level of subscribers receives only median, or representative, quotes
            from the NASDAQthese subscribers are not active traders and are seeking
            only general information about the market
      • Direct trading
          • Direct trading refers to investors trading securities among themselves without
            the use of a licensed broker
          • Direct trading is becoming more and more popular due to the technological
            innovation of ECNs, or electronic communication devices
              • ECNs are alternative trading systems that trade NASDAQ-listed stocks
              • The difference is that they bypass the market makers and allow investors to
                post orders to be matched with orders of investors in the network
              • Because of this, ECNs are particularly used for limit orders
              • Unfortunately, ECNs are not readily available to individual investors but are
                used mostly by institutional investors, such as mutual fund managers

Buy Stocks Directly
 Currently, over 1,000 companies offer these direct stock purchase (DSP) plans
 These plans allow investors to purchase stock directly from the company for either no or
  very low fees
 DSPs are beneficial to investors who want to invest just a little bit each month, such as
  $25 or $50
 After an initial enrollment fee or minimum purchase requirement, investors are free to
  purchase as much or as little stock as they would like
 Most of the time, the company automatically reinvests dividends for the investors
 Before enrolling in a DSP, it‟s important to research the company to make sure it‟s
  reputable

Ways to Place Orders
 Tell your broker in person
 Contact him/her over the phone
 Contact him/her over the Internet (keep in mind that online orders must still go through
  a brokerthey are not immediately executed when you press “send”)
 Some brokers may even be able to receive orders you place from your cell phone or PDA
 Placing an order is relatively simple
 You‟ll need to know:
    How many shares you want to trade
    What restrictions you want to place (if any)
    The ticker symbol for the security

Executing a Trade
 There are a number of ways to execute a trade:
    Sending the order to the floor of the exchange manually
       • After receiving your order, your broker sends it to one of his/her colleagues on the
          floor of the exchange, known as a floor broker
       • That broker then takes the order to a specialist, or a “broker to the brokers”
       • Specialists “make the market” in an individual stock on the exchange, the same
          way market makers do on the NASDAQ
       • At the specialist‟s post, the broker meets with other brokers who are there to trade
          the same stock
       • If your order is to buy, the broker will find other brokers who are selling and look
          for the lowest price
       • If your order is to sell, the broker will find other brokers who are buying and look
          for the highest bid
    Sending the order to the floor of the exchange electronically
       • The electronic system for placing orders on the NYSE is called the
          SuperDOTsystem (Super Designated Order Turnaround System)
       • SuperDOT routes orders directly to the specialist responsible for the security being
          traded
       • This allows for quicker execution than manual transactions
       • SuperDOT is only for trades of fewer than 100,000 shares, and priority is given to
          trades of fewer than 2,100 shares
       • Over 75 percent of all trades on the NYSE go through SuperDOT
       • It‟s important to note that SuperDOT is not the same as an ECN
Executing a Trade
    Sending the order to a market maker
       • For OTC securities, your broker can send your order directly to the market maker
          on NASDAQ
       • This usually provides quick execution
       • Some market makers pay brokers to provide them with order flow
    Filling the order internally
       • Your broker‟s firm most likely owns an extensive inventory of stocks and other
          securities
       • Your broker may choose to fill your order from this inventory
       • This also provides quick execution
      • Your brokerage firm will make money from the transaction as well
 As you can see, your broker may face a conflict of interest when it comes to executing
  your order
    Certain options may benefit your broker or brokerage firm but may not be the best
     options for your and your portfolio
    By law, however, brokers are required to give each order the best possible execution
     for his or her client

Specialists Are Important
 All floor trading for the specialist‟s particular stock takes place at the specialist‟s post
 Specialists can act as both brokers and dealers
 In the broker role, specialists execute the orders of the floor brokers
Specialists Are Important
 Each day, specialists are responsible for setting the security‟s opening price
 Then, throughout the day, they quote prices for the other brokers who come to trade at
  their posts
 Specialists may also execute orders on behalf of their own firm
 Sometimes, however, the trading becomes imbalanced
    There are either too many sell offers and not enough buy offers or too many buy
      offers and not enough sell offers
    When this happens,the specialist becomes a dealer, taking the other side of the
      unfilled trade from his or her own account
    This is known as “maintaining a fair and orderly market”
    Between 10 and 25 percent of the trading volume on the NYSE involves the
      specialists‟ own accounts

Quick CaseSelling Short
 Selling short is like placing a bet
    When investors sell short, they are gambling that a stock‟s value will soon drop in
     price
    So, instead of purchasing a stock the investors think will go up in value, they do the
     exact opposite
    But why would investors do this?
 Selling short can seem like a complicated process, so we‟ll break it down here:
    Investors determine which particular stock they think is about to drop in price
    Investors then borrow shares of that stock from their brokers
    Investors sell the shares and keep the money
    The price of the stock drops (in theory)
    Investors buy shares of the stock at the lower price
    Investors give the shares to their brokers along with interest and commission
    Investors keep the difference, making a profit
 Example:
    Let‟s say you think XYZ stock is going to drop in price very quickly
    You borrow 10 shares from your broker, at no cost to you
    You see the shares for $40 each, making $400
    Remember, you‟ve just made $400 for nothing
    Your gamble pays off, and the price of XYZ stocks drops to $20
    Now, you buy 10 shares of XYZ for $200, leaving you with $200 left over from your
     previous profit
    You give your broker back the 10 shares you owe him as well as $25 interest and
     commission for the transaction
    In the end, your broker makes $25, and you make $175
 It sounds like a great way to make money, but don‟t be fooled
      There are many risks involved in selling short, just as there are with market timing
       and margin
      What if the price of the stock goes up instead of down?
      You won‟t be able to buy back the borrowed shares (known as buying to cover or
       covering the short position) without losing money
      Or what if it takes a long time for the price of the stock to drop?
      The longer it takes, the more interest you‟ll owe your broker and the less profit you‟ll
       have for yourself
      If the process drags on too long, you might actually wind up in debt
   Selling short is a gamble even the seasoned investors and is not recommended for
    beginners