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The exchange and tradingLevel 2Products9 minUpdated How do stock exchanges and trading work?
An exchange is a marketplace where buyers and sellers meet. Once you understand the chain from your own tap of a button to a completed trade, you also understand why the execution price isn't always the one you saw on the screen, and where your money actually goes.
- The difference between the primary market and the secondary market
- How the order book works and where the price is formed
- What the bid and the ask mean
- What happens when you press the buy button
Primary market and secondary market
A company only gets money from its shares once: when it issues them. This is called the primary market, for example an initial public offering or a share issue.
After that, the shares change hands between investors on the secondary market, in other words on the exchange. When you buy a share on the exchange, your money goes to another investor, not to the company.
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Who is on the other side of the trade?
At heart, a price is an agreement. Before we look at how it is formed, it helps to know who is at the table and what each of them is actually trying to do. Nobody has the power to set the price alone.
You, the private investor
An individual buyer or seller who trades on their own account, usually with moderate amounts.
Role
To get a reasonable price quickly without overpaying. You don't set the price: you either accept the offer on the other side or leave your own offer waiting.
Kvarn X and the executing broker
When you place an order in Kvarn X, Kvarn Investment Services Oy (KIS) passes it on to the executing broker, which executes the trade on the trading venue. The shares you buy are held nominee-registered in omnibus custody through regulated custody partners, and they are not transferred to your own book-entry account.
Role
To pass your order on for execution and bring the information about the completed trade back to you. The broker doesn't decide the price; it passes it on.
Market maker
A professional firm that continuously shows both a buy and a sell offer for the same stock.
Role
To provide liquidity and earn the spread. It doesn't take a view on direction. It wants to buy slightly below and sell slightly above, again and again, all day long.
The exchange
A trading venue that collects everyone's orders in one place and runs them through a matching engine.
Role
To maintain a fair, orderly and transparent market: to match orders under the same rules and publish every trade so that everyone sees the same price.
Notice what's missing: none of them decides the stock's “true” value. The price is simply the level at which someone agreed to buy and someone else to sell, at that very moment.
The order book: where the price is formed
The exchange keeps an order book for every stock: a list of buy offers and sell offers with their prices and quantities.
The highest buy offer is the bid and the lowest sell offer is the ask. A trade happens when someone accepts the other side's price. The gap between these two is the spread.
This leads to a practical observation: you can't buy and sell at the same price. Right after you buy, your position is slightly in the red, because you bought at the ask and could only sell at the bid.
What happens when you place an order?
- You give an order to the broker: the stock, the quantity and the price condition.
- The order goes into the order book, or is executed immediately if there is a counterparty at that price.
- The trade is executed and you get a confirmation of the price and quantity.
- Settlement and booking: the trade is usually settled within one or two banking days, and the shares are booked to your holdings. Shares bought in Kvarn X are held nominee-registered in omnibus custody through regulated custody partners, and they are not transferred to your own book-entry account.
- STEP 1OrderYou choose the stock, the quantity and the price condition.
- STEP 2Order bookThe order looks for a counterparty on the exchange.
- STEP 3ExecutionThe trade happens and you get a confirmation.
- STEP 4SettlementThe trade is typically settled in 1–2 banking days, and the shares are booked to your holdings.
A large order can be executed in several lots at different prices if there isn't enough on the other side at a single price level. The final average price then differs from what was shown on the screen.
What does this mean for an investor?
The mechanics of the exchange explain three things that are otherwise confusing.
This content is for information purposes only and should not be construed as investment advice or a recommendation. Investing always involves the risk of losing capital. The value of financial instruments and investments can go up or down, and past performance is no guarantee of future returns.
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