Trading System in Stock Exchange

Trading System in Stock Exchange

A stock exchange is a market for trading in securities. But it is not an ordinary market; it is a market with several peculiar features. In a stock exchange, buyers and sellers do not directly meet and interact with each other for making their trades. The investors (buyers and sellers of securities) trade through brokers who are members of a stock exchange. In stock exchanges, trading procedures are fully automated and member brokers interact and trade through a networked computer system. Trading in a stock exchange takes place in two phases; in the first phase, the member brokers execute their buy or sell orders on behalf of their clients (or investors) and, in the second phase, the securities and cash are exchanged.

For the exchange of securities and cash between the traders, the services of two other agencies are required, namely the clearing house (corporation) of the stock exchange and the depositories. Further, unlike other ordinary markets, stock exchanges are markets where the prices of the items traded (namely, securities) fluctuate constantly. This fluctuation in security prices leads to speculative activities in the stock exchanges.

We need to understand clearly the trading system in stockexchanges, how the trades are settled through exchange of securities and cash, the role of the clearing corporation and the depositories, etc. We also need to understand the different types of speculative activities taking place in a stock exchange. The information about the prices of securities traded in a stock exchange is useful in understanding the behaviour of the stock markets.

Trading System

The system of trading prevailing in stock exchanges for many years was known as floor trading. In this system, trading took place through an open outcry system on the trading floor or ring of the exchange during official trading hours.

In floor trading, buyers and sellers transact business face to face using a variety of signals. Under this system, an investor desirous of buying a security gets in touch with a broker and places a buy order along with the money to buy the security. Similarly, an investor intending to sell a security gets in touch with a broker, places a sell order and hands over the share certificate to be sold.

After the completion of a transaction at the trading floor between the brokers acting on behalf of the investors, the buyer investor would receive the share certificate and the seller investor would receive the cash through their respective brokers.

In the new electronic stock exchanges, which have a fully automated computerised mode of trading, floor trading is replaced with a new system of trading known as screen-based trading. In this new system, the trading ring is replaced by the computer screen and distant participants can trade with each other through the computer network. The member brokers can install trading terminals at any place in the country. A large number of participants, geographically separated from each other, can trade simultaneously at high speeds from their respective locations. The screen-based trading systems are of two types

Quote driven system

Order driven system.

Under the quote driven system, the market-maker, who is the dealer in a particular security, inputs two-way quotes into the system, that is, his bid price (buying price) and offer price (selling price). The market participants then place their orders based on the bid-offer quotes. These are then automatically matched by the system according to certain rules.

Under the order driven system, clients place their buy and sell orders with the brokers. These are then fed into the system. The buy and sell orders are automatically matched by the system according to predetermined rules.