How Stocks Trade….
Probably one of the most confusing aspects of investing is understanding how stocks actually trade. Words such as “bid,” “ask,” “volume,” and “spread” can be quite confusing if you do not understand what they mean.
Depending on which exchange a stock trades, there are two different systems in the US, but luckily for us, there is but a single Singapore Exchange today.
Listed Exchange:
The New York Stock Exchange (NYSE) is perhaps the most famous listed exchange in the world. The US has a second listed exchange known as the American Stock Exchange (AMX), composed of the Boston, Philadelphia, Chicago, and San Francisco Exchanges, and very recently merged with the Nasdaq stock market.
US brokerage firms contribute individuals known as “specialists” who are responsible for all of the trading in a specific stock. With the help of technology, the specialist quickly matches buyers with sellers.
Sometimes referred to as “an auction market,” the specialist can see who has blocks of stock to buy or sell at various prices and links them up. In return for this service, the specialist charges the buyer an extra fee of $6.25 or 12.5 cents per share, depending on the price of the stock. Volume, or the number of shares that trade on a given day, is counted by the specialist.
Over-the-Counter Market:
The Nasdaq stock market, the Nasdaq SmallCap, and the OTC Bulletin Board are the three main over-the-counter markets in the US. In an over-the-counter market, brokerages (also known as broker-dealers) act as market makers for various stocks.
The brokerages interact over a centralized computer system managed by the Nasdaq (National Association of Security Dealers Automated Quotations), providing liquidity for the market to function. One firm represents the seller and offers an ask price (also called the offer), or the price the seller is asking to sell the security. Another firm represents the buyer and gives a bid, or a price at which the buyer will buy the security.
The Nasdaq is looking to become a global exchange opening operations in Europe and Japan to cover all major trading centers and time zones. At the same time, computerized trading systems are springing up in Japan, Hong Kong (GEM), South Korea and many other countries to compete with Nasdaq.
The Singapore Exchange (SGX): works more like the Nasdaq over-the-counter system controlled by a centralized computer quotation system available to all the local broker houses.
et’s take a look at how a particular trade might proceed: a specific stock might be trading at a bid of $6 and an ask price of $6.50. If an investor wanted to sell shares, he would get the bid price of $6 per share; if he wanted to buy shares, he would pay the ask price of $6.50 per share.
The difference is called the spread, which is paid by the buyer. This difference is split between the two firms involved in the transaction. Volume on over-the-counter markets can sometimes be double-counted, as both the buying firm and the selling firm report the activity.
Stock Derivatives-Options & Futures:
Arguably the most volatile and risky investments possible, options and futures are “derivative” securities, meaning their value is “derived” from that of another security or commodity.
Options and futures are both very volatile because they often carry an incredible amount of leverage. For instance, each options contract on an individual stock controls 100 shares (or 100 lots, in Singapore one lot = 1,000 shares) for a fraction of the stock’s current value.
This can make for huge upward moves, but this is offset by the risk of losing 100% of the money put into the option. (Most purchasers of options lose money.) If an investor owns an option and the underlying stock is not within the given price range within the given time period, the option expires worthless.
Many don’t consider “investing” in options to be a very sound strategy—the chances of the options expiring worthless are much too high for options to be considered a useful part of any completely nutritious investment strategy.
