There are certainly plenty of people out there who have an interest in the stock market. It’s easy to get involved in trading stocks, you just pick out a stock, get an online account, click “buy,” and boom, you’re a stock trader!
But what is actually happening when you buy a stock? Where is that stock coming from? Why is the price always a penny or two different from the one when you entered the order? And what ever happened to that trading floor you can see in movies? You know, where everyone’s shouting at each other. Is that still there?
In fact, the precise mechanics of a stock trade may be unfamiliar to even a relatively savvy part-time trader. However, understanding their nature can be important to understanding the markets.
Back to the Origins of the Stock Market…WAY Back
The actual trading of stocks, interestingly enough, remains fairly similar to the way it was done back at the beginnings of the stock market itself in 17th Century Holland. At that time, merchants would gather on a bridge in Amsterdam to trade stock in companies like the Dutch East Indies Company. One would put their hands out, palms up, and shout a price they wanted to sell stock at. A trader potentially interested in the stock would shout a counter offer and slap the hands of the first man. They would go back and forth like this until a price could be agreed upon.
“Joel, I’m trying to learn about stock trading, why are you talking to me about Dutch men in the 1600s standing on a bridge slapping each other?” Fair question. But it would come down to this: that’s still BASICALLY how we do it. Our bridge is now virtual, and our slapping and counter-slapping has been streamlined, but the basics today are the same as they were then.
The Bid-Ask System
So, today, as then, every trade needs to involve a buyer and a seller. And today, as then, each involves a little wiggling around to get a price both sides can agree on. The process is so streamlined at this point that most retail investors don’t even notice it happening…but it’s still there.
The basic system is what’s known as a “bid-ask” system.
Say you have 10,000 shares of Acme (ACME) you’re looking to unload. You would go to the exchange and let it be known that you’re selling that many shares. You would also quote your “ask” price. This is the price you want for your shares of stock. You see that Acme is currently trading at $100 a share, so you might quote an ask price of $100.01.
Meanwhile, somewhere else out there, John Q. Stockbuyer is looking to acquire 10,000 shares of Acme. He heads to the market and lets his desire to purchase be known along with his “bid” price, or the amount he wants to pay. He sees that $100 is the current price, so he might cite a bid of $99.99.
Crossing the Spread
Now, here we have a match made in heaven. A buyer looking to acquire some stock, a seller who needs to sell precisely that many shares. What are the odds that my hypothetical situation would line up so nearly?
Now, say John Q. Stockbuyer really, really needs to get his hands on those shares of Acme. He feels as though the company is severely undervalued and is headed for $150 a share. In that case, the $0.02 a share aren’t important enough for him to pass on this chance to get all 10,000 shares he needs in one go. So, Mr. Stockbuyer will agree to the $100.01 a share so he can get what he wants.
In reality, it’s almost never that simple or clean. Markets actually require “market markers” buying and selling millions of shares of hundreds of different securities to continue functioning (a subject you can read about in more detail in piece on market makers [hyperlink to market markers article]), but those market makers are just figures who facilitate this basic transaction.
New Era, Same Bid-Ask System
Times have changed a lot from those Dutchmen slapping palms on that bridge. Today, our exchanges are virtual. At any given second, the biggest stocks are trading millions of shares between thousands of different sellers and buyers. It’s rarely hard to find a buyer or seller to complete your transaction, and the ready availability of the price stocks are currently trading at means it’s rarely difficult to meet between the bid and ask prices.
However, for all that is different, it’s somewhat surprising how much is exactly the same as it was on that bridge in Holland some 400 years ago.
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