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Today, electronic exchanges like the International Securities Exchange handle a large number of options orders and offer an electronic platform to match option buyers and sellersSTOCK AND STOCK OPTION ORDERS If you are trading the stock market, you begin by placing an order with your broker, who passes it along to a floor broker, who then takes it to the appropriate specialist. At this time, the floor broker may or may not find another floor broker who wants to buy or sell your order. If your broker cannot fill your order, it is left with the specialist who keeps a list of all the unfilled orders, matching them up as prices fluctuate. In this way, specialists are brokers to the floor brokers and receive a commission for every transaction they carry out. Groups of specialists trading similar markets are located near one another. These areas are referred to as trading pits. Once your order has been filled, the floor trader contacts your broker, who in turn contacts you to confirm that your order has been placed. The amazing part of this process is that a market orderone that is to be executed immediatelycan take only seconds to complete. Today, electronic exchanges like the International Securities Exchange handle a large number of options orders and offer an electronic platform to match option buyers and sellers. Your broker, as your intermediary, is paid a commission for his or her efforts. Each completed trade costs $10 on the low end and $100 or more on the high end. Stock commissions may also be based on a percentage value of the securities bought or sold. Remember, your broker should be in the business of looking after your interests, not generating commissions for the brokers own pockets. Since your chief concern as a trader should be to get the transactions executed as you desire and at the best price possible, choosing the right broker is essential to your success. Lets review the stock market order process. The seven steps are: 1. You call your broker. 2. The broker writes your order. 3. Broker transmits your order to an exchange. 4. Floor broker tries to immediately fill your order or takes it to a specialist. 5. A specialist matches your order. If your order is placed as a market order, you get an (almost) imme diate fill. If placed as a limit order, you have to wait until you get the price you want. 6. Confirmation is sent back to the broker. 7. Broker contacts you to confirm that your order has been executed. This is the process for most transactions. In addition to the specialists, there are also market makers who are there to create liquidity and narrow the spread. Market makers trade for themselves or for a firm. Once an order hits the floor, the market makers can participate with the other players on a competitive basis. Stock orders are handled in a similar manner. For example, orders for a stock trading on the New York Stock Exchange or the American Stock Exchange are routed to the floor electronically or to a floor broker by phone. In contrast, Nasdaqalso referred to as the over-the-counter (OTC) marketis an electronic computerized matching system that lists more than 5,000 companies, including a large number of high-tech firms. Brokers can trade directly from their offices using telephones and continuously revised computerized prices. Since they completely bypass the floor traders, they get to keep more of their commissions. There are no specialists, eitherbut there are market makers. Their role is to bid and offer certain shares they specialize in, thereby creating liquidity. They make their money on the spreadthe difference between the bid price and the offer priceas well as on longer-term plays. This difference may be only $0.25 or less. However, when you trade a large number of shares this adds up very quickly. FUTURES (COMMODITY) ORDERS Futures contracts are traded at commodity exchanges. The exchanges are divided into trading pits that are sometimes subdivided into sections of smaller commodities. Individual trades are recorded on trading cards that are turned in to the pit recorder, who time-stamps and keys the transaction into a computer. Some exchanges prefer the use of handheld computers that instantly record the transactions. Orders are filled using an open-outcry system in which the buyers (who make bids) and the sellers (who make offers, otherwise known as the ask) come together to execute trades. For example, in the gold market, if gold is trading at $300 per ounce, you may get a price of $299.50 to $300.50. This means that you would be buying the gold futures contract at $300.50 and you would be selling at $299.50. You may ask, Why cant I buy for the lower price and sell for the higher price? You can try, but the trade will probably not be executed. The floor traders make their living off this spread. They wont want to give it up to you. Lets review the futures market order process. The six steps are: 1. Call your commodity broker (or call direct to the trading floor for large accounts). 2. The broker writes an order ticket or sends your order via computer or calls the trading floor. 3. Floor broker will bid or offer. 4. When your order is matched, the fill is signaled to the desk. 5. The desk calls your broker. 6. Broker contacts you to confirm trade execution. Floor traders primarily make their money on the bid/ask spread. They are the ones who spend (in many cases) thousands of dollars each month for the privilege of being on the floor of the exchange (or hundreds of thousands to buy a seat). They can either lease the seatsgaining the right to trade as an exchange memberor purchase the seats. In addition, they spend each and every day creating liquidity for the investor who is not trading on the exchange floor. For this they want something in returnthe right to make money on the spread. The money to be made on the spread comes from the difference between the bid and offer price. In the gold example, the reward is $1.00 ($300.50 - $299.50 = $1.00). In addition, being right where the action is allows them to see the order flow. Order flow is the buying and selling happening around them. They can spot when large traders are trading. This does give them an advantage, but there are negatives. These include the following five aspects: 1. High monthly expenses. 2. The need to always be in the market to cover costs. 3. Sometimes getting caught up in emotion, not fact. 4. Missed opportunities in other markets. 5. Very physically and mentally demanding work. You probably have watched scenes of the trading pits on television or in movies. You see lots of people yelling and screaming. Is this the way it really is? Yes, when there is action in the market, it can be extremely volatile. If it is slow, people will read newspapers or just stay away. I do suggest that you visit a commodity exchange if you get the chance. It is very exciting and enlightening to experience what really goes on there. Commodity exchanges have to provide safeguards for the public trader. For every buyer there is a matching seller. Clearing firmswhere the funds are heldmust guarantee that each person trading through them has the available funds to meet that traders financial obligations, or they are responsible for the integrity of the transaction. This system of checks and balances has never failed, no matter how crazy the markets have become. Public investors can feel secure that they will not lose their money due to the system failing. |
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