Lesson 3: Stocks

Exchanging Stocks
Exchanges happen through various methods that facilitate the buying and selling of equities between parties who otherwise have no direct contact. There are three primary methods of exchange, each representing a different market for stocks:

• Stock exchanges: The most recognized medium for stock exchanges. These large, centralized exchanges typically operate in big rooms within buildings in major cities worldwide, where brokers, dealers, and others involved in stock trading gather. These exchanges provide services, including electronic communication networks (ECNs) to facilitate trades.

• ECNs: Electronic communication networks are computer networks that connect traders, brokers, dealers, and even stock exchanges to facilitate stock trades. ECNs are now the dominant method for buying and selling stocks.

• OTC markets: Over-the-counter (OTC) markets are a less popular method of stock exchange but often provide access to stocks not available elsewhere. These markets are networks of brokers and dealers communicating outside of formal exchanges. OTC stocks, typically not listed on major exchanges, experience lower volume and attract fewer investors. Information about these stocks is often found in papers called pink sheets, and these stocks are usually identified by ticker symbols ending in .pk.

Looking at the Different Types of Orders
Once you've decided to buy or sell stock, you must determine the type of order you want to place, the price at which you want the transaction to occur, and the timing of the transaction. These factors are controlled through your transaction order. Here’s an overview of how different orders work:

When you want to buy 10 shares of a company like Ford at $10 per share and want the transaction to happen as soon as a seller matches that price, you place an order with your broker or set it up online. The fulfillment of your order depends on finding a seller willing to sell at your specified price.

The price of equities is established through a sort of dual-auction system, where potential buyers and sellers negotiate until a price is agreed upon for the transaction. This is managed through fluctuations in the bid and ask prices of the stock:

• Ask price: The price at which sellers are willing to sell their stock.

• Bid price: The price at which buyers are willing to buy stock.

• Spread: The difference between the ask and bid prices.

The stock price is set when buyers and sellers agree on a price within the spread. The price increases when buyers are willing to pay more, and it decreases when sellers are willing to accept less.

Market order
A market order is the simplest type of stock order. The investor agrees to the price set by the other party in the transaction. If a buyer places a market order, the price automatically becomes the ask price, and the transaction occurs almost instantly. The same happens if a seller places a market order; the price becomes the bid price, and the sale is completed quickly.

Stop and limit orders
Stop and limit orders manage the price at which a transaction occurs. For example, an investor might place an order to buy or sell shares only if the price moves above or below a certain level. When the specified trigger is met, the transaction occurs, assuming a buyer or seller is available at that price.

Pegged order
A pegged order is similar to stop and limit orders, but the trigger price is tied to another variable, like an index or economic metric. When this variable reaches a specific value, the pegged order activates.

Time-contingent order
Time-contingent orders depend on time. Some orders are delayed before they enter the market, while others are canceled if not filled within a specified period. For example, day orders are canceled at the end of the trading day if not fulfilled.

Comparing Long and Short Stocks
Terms like "long" and "short" can be confusing in the context of stock trading. Essentially, these terms relate to whether you own the stock and how long you plan to hold it.

Buying long
Buying long is the most common method of stock trading, where you own the stock immediately after purchase and hold it until you decide to sell. Investors buy long with the hope that the stock’s value will increase, allowing them to sell at a profit later.

Buying on margin
Buying on margin involves borrowing money to purchase stock. This usually requires opening a margin account with a broker, who lends you money to buy stock, often at relatively low interest rates. However, buying on margin can be risky because you must pay interest on the borrowed funds, limiting potential gains and increasing losses.

Selling short
Selling short, or short-selling, involves selling stocks that you don’t currently own, with the obligation to repurchase them later. Investors short-sell when they expect the stock price to drop, allowing them to buy it back at a lower price and make a profit. However, short-selling is risky because if the stock price increases, the potential for loss is unlimited.