Common stocks are also called equity securities. They represent an ownership interest in the company and entitle the owner of the stocks to the share of the cash flows of the company, which is generally referred to as dividends. In case of liquidation, the pro-rata share of the company valuation is shared with the owners.
Preferred stock is another kind of ownership in form of stocks. They are different from the common stocks as they have fixed dividend payments irrespective of the earnings of the company, and are received before any payment is made to the common stock holders. Thus they receive fixed dividend and are senior to the common stocks.
In the United States, secondary market trading in common stocks has occurred in two different ways. The first is on organized exchanges, which are specific geographical locations called trading floors, where representatives of buyers and sellers physically meet. The trading mechanism on exchanges is the auction system, which results from the presence of many competing buyers and sellers assembled in one place.
The second type is via over-the-counter (OTC) trading, which results from geographically dispersed traders or market-makers linked to one another via telecommunication systems. That is, there is no trading floor. This trading mechanism is a negotiated system whereby individual buyers negotiate with individual sellers.
The electronic exchange market has developed in nearly all the countries and allows for instant trade over the communication medium. This medium of trading resembles more of the organised exchange system sans the trading floor.
The markets are categorised as first, second, third and fourth, where the first market refers to the trading on exchanges of stocks listed on an exchange; second market refers to the trading in the OTC market of stocks not listed on an exchange; third market refers to the trading on the OTC market of stocks listed on an exchange; and fourth market refers to the private transaction between institutional investors dealing directly without any intermediary.
Listed stocks are those which are listed on an exchange.
Members are those people who have the right to trade shares on the exchange.
Dually listed stocks allow trading of stocks on more than a single exchange.
A commission broker is an employee of a securities house (“stockbrokers” or “wirehouses”) devoted to handling business on the exchange. Commission brokers execute orders for their firm on behalf of their customers at agreed commission rates. These houses may deal for their own account as well as on behalf of their clients.
Independent floor brokers work on the exchange floor and execute orders for other exchange members who have more orders than they can handle alone or who require assistance in carrying out large orders. Floor brokers take a share in the commission received by the firm they are assisting. Registered traders are individual members who buy and sell for their own account. Alternatively, they may be trustees who maintain membership for the convenience of dealing and to save fees.
Specialists are dealers or market makers assigned by the stock exchange to conduct the auction process and to maintain an orderly market in one or more designated stocks. Specialists may act as both a broker (agent) and a dealer (principal).
Advantages provided by an exchange
Exchange helps in the following:
- Price discovery
- Provides diversity of participants
- Increased availability of capital to the listed companies
- Increase exposure for the company
- Increased accountability of the all the management personnel of the company
- Increased liquidity for the investors
Types of orders
- Market order – order to be fulfilled at the best price available in the market. Here the buyer giving the highest price is given a priority over the lower prices
- Public order – the order which is given be member for investors other than its own firm. This order is given priority over the order given by the members for their own firm.
- Limit order – this has a price threshold designated
- A buy limit order means that the stock is to be purchased only at the given price or lower
- A sell limit order means that the stock is to be sold only at the given price or higher
- Stop order – this order is not to be executed until the market moves to a designated price after which it becomes a market order
- A buy stop order means that the order is not to be executed until the market reaches (rises to) a designated price
- A sell stop order means that the order is not to be executed until the market reaches (falls below) a designated price
- A stop-limit order, a hybrid of a stop order and a limit order, is a stop order that designates a price limit. In contrast to the stop order, which becomes a market order if the stop is reached, the stop-limit order becomes a limit order if the stop is reached. The stop-limit order can be used to cushion the market impact of a stop order. The investor may limit the possible execution price after the activation of the stop. As with a limit order, the limit price may never be reached after the order is activated, which therefore defeats one purpose of the stop order—to protect a profit or limit a loss.
- Market if touched order - This order becomes a market order if a designated price is reached. A market if touched order to buy becomes a market order if the market falls to a given price, while a stop order to buy becomes a market order if the market rises to a given price. Similarly, a market if touched order to sell becomes a market order if the market rises to a specified price, while the stop order to sell becomes a market order if the market falls to a given price. We can think of the stop order as an order designed to get out of an existing position at an acceptable price (without specifying the exact price), and the market if touched order as an order designed to get into a position at an acceptable price (also without specifying the exact price).
- Fill or kill order – this order needs to be executed as soon as it reaches the trading floor or is cancelled
- Open order (good till cancelled) – this order continues to be in existence until it is cancelled specifically
- Round lot – generally consists of 100 shares
- Odd lot – consists of shares less than the round lot
- Block trade – it consists of 10,000 shares or is of value more than US $0.2 million
