 Hello and welcome to the session. This is Professor Farhad and the session would look at how securities are traded. Specifically, we're gonna be looking at the various markets that exist and the order types that exist as well. This topic is covered in an essential or principle of investment course, whether it's a graduate or undergraduate. As always, I would like to remind you to connect with me only then if you haven't done so. YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, finance, tax, as well as Excel tutorial. If you like my lectures, please like them, share them, put them in playlists. If they benefit you, it means they might benefit other people. Connect with me on Instagram. On my website, farhadlectures.com, you'll find additional resources, the supplement and compliment your accounting as well as your finance education. I strongly check out my website. The first thing we're gonna look at is the four types of markets. And those are, the first one is Direct Search. Direct Search is the least organized type of market. Simply put, it's not active, it's sporadic. Simply put, a Direct Search is basically, if you want to sell your car, you may look for a specific seller. So there's no market out there. You are doing this yourself. So you're dealing with your friends, with your family. This is what's called the Direct Search Market. We also have a broker-dealer market. The broker-dealer is more active than the Direct Search because the broker, the person that's working in this market, they find it profitable. It's worth it for them to offer search services to buyers and sellers. What are we talking about here? What would be a broker market? A real estate agent, a real estate broker, because there's a lot of people trying to buy and sell homes. So what you do is you become a broker and this is what the broker-dealer market is. Also another example of it is investment banker. Investment bankers, what they do is they find buyers for companies who are issuing stocks for the first time, which is called the primary market. That's also a broker-dealer market. We also have the dealer market. And the dealer market is NASDAQ. It's an example of a dealer market here. The activity, the trading activity is very active. Otherwise, the dealer don't make a profit. The dealer here, they specialize in various assets. When we're dealing with NASDAQ, usually stocks. And dealers, they purchase those assets for their own account and later they sell them for profit from their inventory. Simply put, think about a store. This is what a dealer market is. Well, if you own a store or a supermarket, what do you do? You buy and you sell. So from a dealer's perspective, they have what's called the bid price and the ask price. What is the bid price? The bid price, it means from a dealer perspective, they're willing to buy. For example, let's assume this is we're dealing with Apple stock. They're willing to buy Apple stock for 365.49 if you want to sell it. But if you want to buy it from them, they will sell it to you for 363.52. You might be saying, hold on a second, aren't you buying less than what you're selling it? Of course, because this is the spread. The spread here is three pennies. The spread is the dealer's profit. Now, is the spread always three pennies? The spread depends on manufacturer. One thing is the riskiness of the stock. If the stock is not active, it doesn't have liquidity. It doesn't have depth in the market. Well, the spread is higher. Why? Because you are taking a risk when you buy and sell that stock. Also the volume. If you buy shares in 100 lots, the spread is usually lower because this is how shares are traded. Also the availability. If the broker has the stock available, if the dealer has the stock available, then they're gonna charge you a lower spread than if they want to go out and buy it. And this process happened within milliseconds. So let's assume the dealer does not have the stock. It doesn't mean they have to spend time, go look for it. Automatically, their system will go ahead and buy it from somewhere else, but you might have a higher spread. So the availability also matters. We also have the auction market, the fourth type of market. What is the auction market? Think about the NYSE, where all the traders can converge to buy and sell into a one location or one electronic platform. This is what an auction market is. Market three and market four, this is called the secondary market. And what is a secondary market? It means we're traders, investors among themselves, trade stocks. So when I buy stock, today I bought stocks, today I sold stocks, I am dealing in the secondary market because I bought those stocks from another person, from another dealer. I'm sorry, could be a dealer, but not from the company itself, not primary market. So the dealer market and auction market mainly deal with secondary market. Now, moving from market to order types. When you buy and sell stocks, you have two type of orders. You have market orders and price contingent orders because you have many of them. So let's take a look first at market orders. And when you place a stock, when you place a buy or a sell stock, using a market order, it means you care about the speed. You want to sell or buy as soon as possible. So market orders are to buy and sell to be executed immediately. Speed is what matter at the current price. Now I put the current price in quote because you know, you don't know the current price, you know the latest price, but what you sell at is the next price. You don't know what the next price is. So let's assume there is a bid price of 365.49 and an ask price of 365.52. And let's assume you want to buy Apple 365.52. Well, here's what's going to happen. Let's assume this is I'm logged into my account here and I want to buy 100 shares of Apple and this is the bid and this is the ask. So basically that's the bid and that's the ask. And basically if I want to buy it, I'm going to be buying it at the ask price 365.52. Now this is the last, this is the last ask price. It doesn't mean I'm going to buy it at 365.52. There's a good chance I will because first of all, I'm buying 100 shares, okay? And Apple is a heavily traded stock. So there's a lot of shares traded out there. But if I want to buy 100,000 shares of Apple, yeah, I wish I can, I can do that. Then although the ask price is 365.62, when I place the order, most likely it will be a little bit higher unless there's somebody else who wants to sell 200,000 shares of Apple, then the price could be even lower. The point is what I see if I place a market order, this price is not guaranteed. The 365.52 is not guaranteed. This is the latest time the Apple was sold at, okay? So the next time it could be close to it, okay? So this, remember the market order, it's not guaranteed, it depends on many factors. So the posted prices are actually, actually represent commitment to trade up to a specified number of shares. So they could be for 1,000 shares, but if you want to buy 2,000 shares, there's a good chance the price could go up unless that moment specifically, somebody else wants to buy 5,000 shares, then you could even buy it less than what you were seeing. The point is you don't know the price. Now if you buy S&P 500 stock price, there's a good chance you may get that stock within few pennies, but if you buy Russell's at 2,000 stocks because it's not actively traded, the price could be different. So the best price that was quoted may change before your order arrived. So make sure market orders, you may not get that price exactly. So cause and execution at a different price from the one at the moment that you saw the order. Now, so what should you do? Well, what you should do is you should place a price contingent order. And what is price contingent order? Here you specify what price you want to buy at and what price you want to sell at. So the investor may place orders specifying prices at which they are willing to buy or to sell. Here you are specifying the price. So you might place what's called a limit by order and you will instruct the broker to buy some number of shares if and when they obtained a below at or below stipulated price. And we'll look at an example in a moment and you could also place a sell limit instruct the broker to sell it when the price rise above a specified limit. Let's take a look at an example. And again, this is from my brokerage account showing you a sample. Let's assume I want to buy 100 shares of Apple. Okay, so Apple, I want to buy 100 shares quantity and I want a limit. Right now, if I want to buy the latest trade is 365.52. Well, guess what? I want to buy it only if it drops to 360.25. So notice the bite, the limit is I place it below. Because think about it, I'm not gonna ask the computer to buy it at 366. Why would I do that if I can buy it at 365.52? So I want to buy it once it reaches 360.25. Once it reaches 360.25, assume when somebody is willing to sell 100 shares at that price, which is Apple's very active, I will buy it. Now the same thing could happen. If I want, if I have Apple shares, I can sell the 100 shares at a limit. So let's assume it's traded at 365.52. And I'm concerned, I would say, look, if it reaches 364, sell it. Means I want to sell it, if it's keep on dropping, I want to sell it at 364. Or if I want to sell it at 365.25. Or I want to sell it when it reaches 366, I can place that order. So the sell is basically, once it reaches a certain price, if I have it, sell it for me. So you could have a buy or a sell limit, buy or a sell limit. Now you could also have what's called, if I have shares of Apple, I could have what's called a stop. What is a stop? It means once, once, let's assume it's trading right now, notice selling at 366.22. And let's assume I'm concerned that Apple might keep on dropping. So I'll place a stop order. I would say once it reaches 365, once it reaches 365, I'll place the order to sell 100 shares. Once it reaches 365. So hold on a second. What's the difference between the stop and the limit? Stop means it means once it triggers that price, the next, the next, or the next trade will be yours. So it reaches that trigger point. So once it reaches 365, it may go up to 365.25. Or it may go down to 364.75. So it reaches that stop yourself. Same thing when you want to buy. Let's assume you want to buy Apple. You'll tell the system, once it reaches 370, you want to buy. You may buy it at 370, but you may buy it at 371. Look at the different color. Or you may buy it at 369. Look at the different color. Okay, I'll pick the green. Is that okay? Yes. Okay, that's it. Okay, Dada. Okay, so my son wanted me to change the color. So the stop order basically, once it reaches that number, you may buy it at 370, or you may sell it at 370 or buy it. Or it may not. Once it reaches that price, it triggers. There's also stop, then limit. Stop means it's one, it reaches that. Once it reaches 370 or 360, then you automatically place a limit order to sell it at 359. Then you specify what you want to sell it at. So it's a stop limit. And the same thing, there's a buy stop limit. It means once it reaches that price, I'm gonna place a price test to buy it. Because the stop alone, you don't know what the next rate is. The stop limit, it triggers, it got there. Then you wanted to buy it or sell it at that point. Let's look at the trading mechanism. So how do you buy and sell stocks? Well, an investor who wishes to buy or sell shares, you place the order with your brokerage firm. Usually it's on the computer. You don't call them or see them or anything like that. Broadly speaking, there are three ways, three trading system employed in the US. One is over the counter, OTC. The other one is electronic communication network. And the third one is a specialist market. The electronic trading is by far the most relevant. Simply put, over the counter is electronic. And obviously electronic is electronic as well. Specialists is a little bit different. We'll talk about the specialist. So those, but the best known market such as NASDAQ or the NYSE actually uses a variety of trading procedures. The NYSE, they still use this market, this specialist market, NASDAQ uses electronic platform. So let's take a look at the over the counter on specifically we're gonna talk about the NASDAQ. What is over the counter? Over the counter is an informal network of brokers and dealers who negotiated sales of prices. Think about a bunch of people. And there are roughly 3,500 securities traded on the OTC over the counter. And there are thousands of broker dealers registered with the SEC to trade on this platform. So basically in 1971, this is how it all started. The National Association of Security Dealers introduced its automatic quotation system or NASDAQ to link broker dealers in a computer network where price quotes could be displayed and revised. So when NASDAQ started, it was just only a system, a computer system. Think about the 1970s computers where they could show you the price of the stock. What's the latest price of the stock? Now, if you want to buy and sell, you would have to actually talk to the other person, talk to them on the phone. So dealers could use the network to display, notice to show the bid and the ask prices, which is price quotation. Now NASDAQ obviously had progressed far beyond just a quotation system. Now the system can execute the trade. Now market allows for electronic execution at quoted prices without the need for direct negotiation, without the need to call someone. And the vast majority of trades are executed electronically. In the next session, we'll talk a little bit more about the rise of electronic trading in the US. So we'll talk about this topic a little bit more. Another system at electronic, the ECN, which stands for electronic communication network. And this one is basically its electronic system, allow participant to post market and limit orders over a computer system, over a computer network. And we'll talk about those again in the next session. The limit order book is available to all participants. So all participants who participate in this network, they can see the limit order. They can see what prices people are willing to buy and sell at limit prices. Orders that can be crossed, it means the system will match them. So if there's somebody wants to buy Apple at 365, buy 100 shares, and someone wants to sell Apple at 365, 100 shares, the system will match them. Now, I do participate basically, I do have access to this ECN. Actually, I will show you in a moment on the next slide. For example, in order to buy shares at 149.75 or lower will be immediately executed for 149.75 when there's somebody is willing to sell. So it automatically does this. ECN are through trading system, not price quotation. They're computer networks that allow direct trading without the need of market makers. They're attractive because of the speed at which the trade can be executed without any intervention. Now, I do have access to the ECN system. I don't know exactly which ECN system, but basically once the market closes, I have Charles Schwab account. I can go to my extended hours and I can click on the extended hours. Now the extended hours are closed, but when you click on the extended hours, I can buy shares when even the market is closed. Why? Because I'm part of this ECN, my Charles Schwab account is part of the ECN and there's somebody else out there. If I want to buy, they want to sell. If I want to sell, they want to buy and they matched us electronically. Now there's the specialist market and this is basically kind of old in one way or another, not old, but it's going away little by little. The specialist serves as a dealer and the stock and provide liquidity to other traders. So what is a specialist? It's usually a company, but represented by a person, but a physical person on the floor. So brokers wishing to buy or sell shares for their client, direct the trade to the specialist, post, there's a post, there's a physical post on the floor of the exchange. Let's look something like this. And when I worked with Merrill Lynch long time ago, they took us to the NYSE, we were just new employees and they showed us all of this one day. So basically the way it works, let's assume this is the specialist. Let's assume someone in California, they want to buy 100 shares, 100,000 shares of Apple computers, of Apple. Here's what happened. They have a Charles Schwab account. Automatically, Charles Schwab, the system, they will try to match. So somebody wants to buy 100,000 shares. They will try to match it with somebody who wants to sell, the system does this, sell somebody, this person in California and this person in Florida. Somebody wants to sell 100,000 shares in Florida. So they match the order. So let's assume somebody wants to buy 100,000 shares and in the whole country, there's only 75,000 shares. At this moment, they want the sell on the network. So what happened is, what happened is you cannot fill the order. What's gonna happen is you're gonna have 25,000 shares remaining of Apple. So here's what happened. Automatically, Schwab will send a signal to Der Guy. This is Schwab's guy on the exchange. And they say, we need immediately to buy 25,000 shares of Apple computers. This guy will go to the specialist. This guy is the specialist who specialized in Apple computers. This could be JP Morgan, could be someone else. And they'll be able to get them the 25,000 shares. Obviously, it'll be a little bit more at a higher price because there's not enough seller, but the point is they will make a market in that stock. So they will make sure you will get your stock. So a company that makes a market and the shares of one or more firms maintain a fair and orderly market. If this person did not exist and there's an order to buy 25,000 shares, the price could jump substantially. But here comes the specialist and they will sell it from their own stock. They'll say, if you want Apple, just come to me, I will buy. I will sell you Apple, okay? So they will have it in their inventory. Again, the specialist has been largely replaced by electronic communication network. Okay, why? Because everybody is trading online and there's enough buyers and sellers to keep the market orderly, okay? They are still one of the most important things by which stocks are traded. We are there in mind, okay? Because when there's imbalance, you'll need to go to those specialists. So the specialist maintain a limit order book of all outstanding and executed limit order. So they see what's going on if there's any limit order and they can project if there's a lot of buyers or sellers and they'll try to kind of match them with the best prices. In the next session, we would look at the rise of electronic trading. As always, I would like to remind you to like my recording, share it, put it in playlist. If it benefits you, it might benefit other people and don't forget to visit my website, farhatlectures.com. If you are planning to compliment or supplement or supplement your accounting or finance courses or CPA or CFA exam. Good luck and study hard.