What Is the Trading Mechanism in the Stock Exchange?
The trading mechanism in the stock exchange is based on a transaction between a buyer, seller, and a trading specialist who actually executes transactions in a stock exchange. In general, the trading mechanism is similar to a simple auction, with investors biddng on a particular stock or security. If the bid is accepted by the owner of the security, the trading specialist executes the sale. Most major stock exchanges trade a collection of stocks, bonds, and other domestic and foreign investments.
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Purpose
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The trading mechanism exists because of the constant need to channel money from investors into business entities. Investors range from wealthy individuals and investment funds to small-scale investors saving for retirement. Entities that raise money in the stock market include corporations, governments, and government agencies. The combination of investors and borrowers creates the market for securities. The trading mechanism refines the market by matching buyers and sellers with the prices they are willing to pay or take.
Bid Price
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A potential buyer of a particular security proposes a price for the security. This is commonly called a bid price. This bid reflects how much the buyer is willing to pay to buy the security.
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Ask Price
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The ask price is amount the owner wants for the stock or other security. Generally, the ask price and the bid price are different. This difference between bid and ask price is usually called a spread. For the trading specialist, the spread is an opportunity to make money from the trade.
Trade
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The trade specialist working in the stock exchange itself is the most important part of the trading mechanism, because he matches buyers with sellers. In addition to making the trade happen, a trade specialist must have a ready supply of the security being bought and sold, to avoid corruption and distortion in stock market transactions. Trade specialists can also calculate the supply and demand levels of certain securities of stocks.
Supply and Demand
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Supply and demand theories help illustrate the market forces that influence the trading mechanism in the stock exchange. These forces affect the trading specialist inventories as well as the bid and ask prices. Generally, a certain stock or other security might increase in price if it is highly sought by investors. High demand can cause sellers to increase their ask prices because the security is worth more. In turn, buyers may be willing to increase bid prices because of the improved value of the security. As more buyers seek out an investment with upward momentum, traders must react with increased inventories to meet the demand for the security.
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References
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- Photo Credit new york stock exchange image by Gary from Fotolia.com
