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