Secondary Markets and How Securities are Traded
After new stocks have been sold, investors can trade them on the
secondary markets. The company (original issuer of the securities)
does not receive any proceeds on these trades. Instead, the trades
are made between the buyers and sellers of the securities. The
secondary markets are important for providing not only liquidity
and fair pricing for securities but also a baseline for the pricing of
new issues and IPOs.
How Stocks Are Traded
Individual investors place their orders for stocks through their brokers,
who buy and sell stocks for their investors. These orders can
be filled in two major trading systems: the auction market and the
An auction market is a centralized location where bid and ask prices
are given for stocks. Bid and ask prices are matched by specialists
and floor brokers in an open-outcry auction; shares with the lowest
ask price are bought from investors, and shares with the highest
bid prices are sold to investors. This process takes place on the
NYSE and the AMEX. A specialist is a member of an exchange
who makes a market in one or more of the securities listed on the
An example best illustrates the process of order execution on
the NYSE. Suppose that you are an interested in buying 200 shares
of Home Depot, Inc. You call your broker for a quote or go online
for this information. The bid price is $34.90 per share, and the ask
price is $34.91 per share. The bid means that the specialist is willing
to buy Home Depot shares at $34.90 per share, and the ask means
that the specialist is willing to sell Home Depot shares at $34.91 per
share. The spread is $0.01 per share. On the NYSE, the Home Depot
specialist makes a market in the stock.
You then decide to buy 200 shares of Home Depot at the market
price. The transaction should be close to the $34.91 price per share if
you place the order immediately after receiving the quote and if the
market price of Home Depot does not fluctuate widely.
Your broker fills out a buy order (or you fill out an online order),
which is transmitted electronically to the floor of the exchange.
Figure 7–1 provides an example of an online buy-sell order. There,
the floor broker (member of an exchange who executes orders on the
exchange floor) takes the order to the Home Depot trading post to
execute the buy order, from either another floor broker who has a sell
order for 200 Home Depot shares or the specialist. When your order
is executed, the brokerage firm mails or e-mails you a confirmation
that the order has been executed.
Specialists are allowed to trade the assigned stocks in their
own accounts and to profit from those trades. However, specialists
are required to maintain a fair and orderly market in stocks
assigned to them. For example, specialists are not allowed to compete
with customers’ orders. If a customer places a market order to
buy, the specialist cannot buy for his or her own account ahead of
the unexecuted market order. Similarly, specialists cannot sell from
their accounts ahead of unexecuted market orders to sell. The purpose
of allowing specialists to act as traders is to minimize the
effects of imbalances in the supply and demand of assigned stocks.
Specialists are prohibited by law from manipulating stock prices.
Even though the SEC monitors the trading activities of specialists
and ensures that they follow its numerous rules, maintaining an
orderly market, along with the profit motivations of the specialist,
means stepping into a gray area. The reputation of the NYSE was
tarnished by trading abuses of specialists and floor brokers on
the exchange floor who traded stocks ahead of investors’ orders
for their own profit in 2003. A useful Web site providing basic
information on the markets and how those markets work is
In a dealer market, dealers make markets in stocks from their
inventories by using a computerized system. Numerous dealers
can provide both bid and ask prices for the same stock. This form
of trading takes place in the Nasdaq system for OTC trades. The
NASD implemented the Nasdaq, which allows subscribing brokerage
firms to obtain price quotations on stocks in the system.
A Typical Online Order Ticket
When buying or selling an OTC stock, you place an order with
a brokerage firm. That order is sent to the brokerage firm’s trading
department, which then shops among that stock’s market makers
for the best price. To serve the needs of different brokerage firms,
the Nasdaq provides three levels of quotes:
Level 1. This basic level provides a single quote for each stock.
The price is updated continuously.
Level 2. This level provides instantaneous quotes (bid and ask
prices) for Nasdaq stocks from all the different market makers.
Abrokerage firm takes an investor’s order for a particular
stock to find the best price (the lowest ask price if the investor
is buying and the highest bid price if the investor is selling)
from those quotes.
Level 3. This level, for market makers and dealers, provides
level 2 quotes and the capacity to change those quotes.
Many criticisms have been leveled at the potential conflict of
interest between market makers and dealers regarding execution of
trades on the OTC market. That brokerage firms can act simultaneously
as agents for their customers and self-interested dealers might
be a conflict of interest. Acting as an agent, a broker should find the
best price for customers. This responsibility becomes blurred when
the agent’s brokerage firm is also looking to profit from the deals it
makes. You have no need to look for more competitive prices if your
brokerage firm can fill your order as a market maker and thereby fulfill
its profit objective.
Categories in Trading Mistakes
Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor
Using too much Leverage
Determining the proper capital requirements for trading is a difficult task
Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure
Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader
Useful Advices to Beginning Trader
You can control your success or failure
All about Stocks
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