BizNet OnLine Magazine, Mr. Money Know' s, How The Stock Market Works

Mr. Money - Know' s
By: Dana Goldfarb
Financial Writer
dana@biznetonline.com

HOW THE STOCK MARKET WORKS

Last month, you remember we discussed taking public my imaginary corporation, Gizwich Corp. So, now that it's public, and trading on the New York Stock Exchange, let's say that you want to buy 100 shares. Have you ever wondered what happens to your order once it's entered? Let's take a look....

You've decided that you will pay whatever the best price of Gizwich is at the time your order is entered. You enter an order through your broker, and it is quickly sent to the NYSE. A "floor broker", who is an employee of your broker's firm, and who is located on the trading floor, receives the order and proceeds to the "trading post" where Gizwich shares are bought and sold. Gizwich, like every other stock listed on the New York and American stock exchanges, is traded at a specific location, or "post", and has a "specialist" assigned to it. The specialist's primary function is to "insure a fair and orderly market" in each assigned stock by buying and selling for his own account in the absence of other competing bids and offers. In other words, he keeps the auction going between buyers and sellers of a stock. If there are no sellers of Gizwich when your market order hits the floor, for example, then the specialist must step in and sell you 100 shares from his own inventory at whatever the market price is at the time. On the flip side, if you were selling 100 shares, and there was nobody there to buy them, the specialist would again step in, this time buying the shares for his inventory.

At the post, your floor broker enters the "crowd", a group of two or more brokers who also have orders for Gizwich. "How's Gizwich?" asks your broker. "Twenty five and one half to three quarters," the specialist replies. This is the current bid and asked quotation. This means that 25 1/2 is the best bid, or the highest price anyone in the crowd is willing to pay you if you were selling Gizwich, and 25 3/4 is the best asked price, or the lowest price anyone in the crowd is willing to sell you their Gizwich shares for. The difference between the two prices is the spread.

Your broker may try to get a better price by saying "twenty five and five eighths for 100." Perhaps at this price another broker in the crowd hollers "sold" feeling that this is the best price he can receive for the order he is responsible for selling. The transaction has been completed. In this case, at a slightly better price than the current asked price. The trade is recorded and printed on the consolidated tape which your broker will see on his screen, or you will see on the bottom of your television screen if you're watching CNBC.

What if your order isn't a market order. Let's say you won't spend a penny over 25 a share. In this case, the floor broker will leave the order with the specialist who will put it in his "book." The specialist's book is for orders that are "away from the market." If the price of Gizwich gets down to 25, the specialist will begin executing those orders on his book. However, it is not a guarantee that your order will be filled if the price descends to 25. The market may move back up before all orders on the specialist's book can be executed.

Here's another "what if?" What if Gizwich doesn't trade on the NYSE, but over-the-counter? Well, it will be handled differently. Your order will be sent to your brokerage firm's OTC trading desk. If your firm "makes a market" in Gizwich the trader will fill the order from his inventory. In this case, he is acting as a principal, or dealer. As a market maker, he has to maintain an inventory of Gizwich, be prepared to buy or sell at least 100 shares at any time, and must post bid and asked prices continuously.

If your broker is not a market maker in Gizwich, and the stock is quoted on the NASDAQ (National Association of Securities Dealers and Quotations) System, he will query his computer by entering Gizwich's trading symbol. The names of all market makers, with their respective bid and ask quotations will appear on his screen. The trader will then call the market maker offering the best quote, negotiate a price, and buy the stock for you.

Regardless of how or where the stock trades, the movement in price reflects supply and demand. More sellers (more supply) means a lower stock price; more buyers (more demand) means a higher stock price.

Your lesson for the day is now over.

Dana Goldfarb is a broker for Sutro & Company In Woodland Hills Ca.
And Can Be Reached At (818) 313-8700

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