How Stock Trading Works

Do you trade stocks? If you do, have you ever wondered what happened after you clicked the button and submitted your trading order?

In the early days, if you were to buy shares of a stock, you would have to call a stock broker who may hold a seat on NYSE floor and the broker would then get a quote of the stock from a market maker before placing the order, buy or sell, on your behalf.  Today, with electronic systems replaces manual operations, things are quite different and simple. Anyone who has a brokerage account with any of the discount brokers can place a trade. All he or she needs to do is log into the account, enter the symbol of the stock he or she wants to trade and the number of shares, set price limit (or without any specification in a market order) and place the trade. For a market order, you will receive a confirmation after the order is executed, which takes only seconds after the order is submitted, and the trading process is completed. But do you know where your order went and how it was executed after hitting that Submit button?

NYSE stock trading

Last week, I came across an early article on CNBC about how stock orders places by individual investors through a discount broker got executed. Basically, stock trading nowadays is all about technology, liquidity and complexity as the article pointed out. For those using discount brokers to trade stocks, the article uses Scottrade (see Scottrade review for more details about the broker) as an example to show how it is done. According to the article, when an order is placed at Scottrade to trade a stock, it uses more than one market maker, including Knight Capital, UBS, Citadel and Citigroup, to find the best quote for the order. When multiple quotes from these market makers, whose job is to match the buyers and sellers of the same security, are received at Scottrade, it will use a set of criteria to determine where the order should be sent to. The criteria used in the routing decision include price, speed of execution and quality of service.

For market makers, if they can’t fulfill the order with their internal inventory, i.e., match the buy order with a sell order that has already been executed, they will turn to other resources to get the shares needed for the other. If there’s a price difference between the buy and sell order, the market maker will profit from the trade and a portion of the profit will be sent back to Scottrade as a rebate for sending the order their way. Usually, the rebates are “typically a tenth of a cent per share”, according to the article. Of course, since I am a customer, I don’t want the amount of rebates affects Scottrade when it chooses which market maker to send my orders. I am glad that they said that’s not a one of the criteria.

BTW, if you are new to stock trading, here’s a short video from TradeKing, another popular discount broker, explaining how to place an order with TradeKing. Even though the video is made by TradeKing and is specific for TradeKing customers, the process is quite similar to any other discount brokers.

You can find out more about TradeKing from an early discussion on how to open an account, how much it costs to trade, and trading tools it offers.

Photo credit: Claudia R M Maia

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