Unit 8 – Trading Securities

Secondary markets

an aftermarket where investors can easily buy and sell securities to each other apart from the issuer (Nadaq, NYSE, and NYSE)

Securities Exchange Act of 1934

created the SEC and gave it authority to regulate securities exchanges and the OTC market

Market center

a physical or virtual location where buyers and sellers of securities can connect to trade securities, four in the U.S. (exchanges, OTC market, third market, and fourth market)

Exchanges

an auction market (or double-auction market) where member firms trade listed securities with one another, help maintain fair and orderly markets through floor brokers, DMMs, and electronic trading systems done at a physical location (trading floor) but mostly virtually

Listed securities

securities that trade on an exchange

Floor brokers

execute (buy and sell) trade for their firms and customers

Designated market members (DMMs)

registered trader in exchange that are assigned specific stock, maintains an inventory of assigned securities, facilitates trades, and is expected to maintain a fair and orderly market by buying and selling their inventory to keep the market balanced

Over-the-counter market (OTC)

a decentralized (no floor) market where unlisted securities trade directly between market makers rather than on a physical exchange, most debt securities and a center for smaller companies

Unlisted (nonlisted) securities

securities traded in the OTC market

Market makers

specialized BDs that facilitate trading of OTC securities they provide liquidity ensuring there is always a market by quoting prices, reduce spread by offering competing bids, and absorb market volatility as they buy/sell their own inventories

Spread

primary source of revenue for market makers to compensate for the risks they take on (inventory risk, market risk, and operational costs), the profit they make

Markup

difference between the lowest current offering price among dealers and the higher price a dealer charges a customer, the profit made by a dealer when selling a security to a customer

Markdown

difference between the highest current bid price among dealers and the lower price that a dealer pays to a customer

Third market (Nasdaq intermarket)

registered exchange that operates as part of the OTC market center, stocks are listed stocks but trade through the dealer network between BDs and market makers (like the OTC)

Fourth market

market for institutional investors where large blocks of stock trade, with other institutional investors and without the use of BDs transaction occurs through ECNs, orders are not made public until after trade is complete so they are less transparent (aka dark pools)

Electronic communication networks (ECNs)

system protects institutional investors from revealing their trades and the market from orders that might be disruptive because they are so large, open 24 hours a day

Dark pools

designed to help institutional traders operate in a less transparent setting than the exchanges allowing them to trade with less disruption of the secondary markets, also helps institutional money managers by making it more difficult to determine the strategies they are using

Investor

they are the seller of a security in the secondary market that wants to generate cash to do something else with it (retail investors, day traders, accredited investors, institutional investors, fiduciaries, and IAs)

Retail investors

normal people who are investing their own money to accomplish their own objectives, generally not professional investors, rules on disclosure, communications, and recommendations are designed to help them

Day trader

type of retail investor that trades rapidly in and out of positions, most make trades throughout the day then end the day flat (with no positions in their account)

Accredited investors

no specific use in secondary markets, but it may be used to identify a wealthier or more sophisticated retail investor

Institutional investors

large investor like a mutual fund, pension fund, bank, insurance company, or some other financial organization, decisions are often made by a professional (IA) who is paid by the institution to manage the portfolio

Fiduciary

a person who manages assets for another person (the beneficiary) having a legal an moral obligation to perform their duties in the best interest of the beneficiary – custodians, guardians, or executors

Custodians

those who manage a minor's account under the Uniform Transfers to Minors Act (UTMA), may also refer to a firm that holds assets in a qualified retirement account

Trustees

fiduciaries that oversee a trust, might be a living trust, a pension trust, or any other sort of trust

Guardians

normally court-appointed custodians over a minor or an incapacitated adult

Executors

custodians of estates (all the money and property owned by a particular person at death)

Investment advisers (IAs)

anyone who (1) gives investment advice; (2) provides this advice as a regular part of their business; and (3) does so for compensation, they as a fiduciary for a customer (must pass Series 65)

Facilitators

help customers perform transactions in the secondary market

Broker dealers (BDs)

FINRA member firms operating under membership agreement and other SROs that perform securities transactions for their own accounts or their customers, primary source of revenue is transaction fees (commissions and loads) and may never state that they are endorsed, approved, or recommended by a regulator

Carrying firms (clearing firms)

carries customer accounts and accepts funds and securities from customers, they can do trade executions, clear/settle transactions, take custody of customer funds and securities, and handle all back-office tasks (i.e. TCRs and statements), typically among larger BDs - must segregate (hold separately) customer funds and securities, cannot combine the firm's assets with client assets

Fully disclosed firms (introducing BD)

introduces its customers to a clearing firm, has ability to execute trades for its customers (and often does), but the settlement (clearing) of the trade falls to the clearing firm

Clearing firm

acts as introducing firm’s back office, holds the funds and securities of the introducing firm's customers and performs related functions (i.e. sending confirmations and statements)

Prime brokers

holds the client's assets, provides custody and account services, sends trade confirmations and account statements, and handles clearing and settlement (centralizes the reporting of the trades) - often execute some of their customers' transactions but can send a trade to an executing broker

Prime brokerage account

allows a large investor (usually an institution) to keep all cash and securities in one central account with a prime broker, while using multiple executing brokers to place trades

Transfer agent

maintains a count of the total number of shares of a company that are authorized and outstanding also responsible for

• Ensuring that the company's securities are issued in the correct owner's name

• Canceling old and issuing new certificates

• Maintaining records of ownership

• Handling problems relating to lost, stolen, or destroyed certificates

• Ensuring that shares are properly registered

Registrars

always a firm that is separate from the issuer and transfer agent, licensed by the states and provide audit and oversight services for the transfer agents

Clearing agency (clearing corporation)

intermediary between the buy side and the sell side of a transaction ensuring that trades are settled correctly and that securities are properly transferred from one owner to the next, receives and delivers payments and securities on behalf of both parties

Depository trust and clearing corporations (DTCC)

world’s largest depository for securities providing custody services for virtually all securities except those subject to transfer or ownership restrictions

Options Clearing Corporation (OCC)

clearing agent for options contracts to standardize, guarantee the performance of, and issue options contracts (acts as issuer and guarantor)

Bull

if a person believes the market overall or a specific stock is likely to go up in value, long a stock

Bear

if a person believes the market overall or a specific stock is going to go down in value, short a stock

Bid price

highest amount someone is currently willing to pay for the security, size is the number of shares that someone is willing to buy (often in round lots each being 100 shares)

Ask price (or offer)

lowest amount someone is currently willing to sell the security for, size is the number of shares that someone is willing to sell (often in round lots each being 100 shares)

Size of order

quantity of shares available at the highest bid and lowest ask prices

Spread

difference between the bid and ask prices

Quotes for stocks

managed by DMM that maintains an order book containing all open limit orders for their assigned stock

Highest buy limit

most someone will pay for the stock and establishes the bid, size of the limit order establishes the size

Lowest sell limit

least someone will sell their stock at and establishes the ask, size of the limit order establishes the size

Quotes for OTC stocks/bond

trading between BDs, bid is highest bid from a market maker and the ask is lowest ask from a market maker

Inside market/inside quote

highest bid and lowest ask

Market order

buy or sell a security immediately at the best available price, investor wants trade executed quickly, not with receiving a specific price (has priority over orders with restrictions)

Limit order

order that instructs trader to buy a specific security below a certain price or sell above a certain price, guaranteed the limit price or better but not a trade

Buy limit order

maximum price customer will pay, may get a lower price if available but will not pay a penny more than the limit price

Sell limit order

minimum price the customer will accept, may get a higher price but will not take a penny less than the limit price

Stop orders

a specific trigger price (stop price) is reached. Once triggered, it becomes a market order and is executed at the next available price (commonly used to limit losses or protect profit)

Stop/trigger price

price that activates the stop order. When the stock reaches or passes this price, the stop order is triggered (elected) and becomes a market order

Sell stop

protective order used to sell a stock if it begins to move down, stop price is below market price when triggered it becomes a market order to sell (protects a long position)

Buy stop

protective order used to buy a stock that is starting to move up, stop price is above market price when triggered becomes a market order to buy (protects a short position)

Day order

order that is valid only until the close of trading on the day it’s entered, if not executed or partially executed by the close of trading it is cancelled (most common)

Good-til-cancel order (GTC)

orders are valid until executed or canceled, BDs impose limits on how long it may remain open before cancelling

Fill-or-kill order (FOK)

instruction to fill the entire order immediately or kill (cancel) the order completely, can’t be a partial execution

Immediate-or-cancel (IOC) order

like FOK orders except that a partial execution is acceptable, if only a portion of the order can be filled, it is, and the remaining unexecuted portion is canceled

All-or-none (AON) order

orders must be executed in their entirety or not at all, can be day orders or GTC orders differ from FOKs as they don’t have to be filled immediately

Long position

when an investor buys a security, they now own the security (buy to open, sell to close)

Bullish position

someone who is long the security hopes that the security will rise in value and that they will be able to sell it later for a profit

Cost basis

amount customer paid for the position

Short sale

investor is selling a security they don't own by borrowing stock from a stock lender and selling the borrowed shares hoping that the stock price will decline so they can buy them back at a lower price (sell to open, buy to close)

Bearish position

customer profits from the difference between the sale price and the price at which the shares are bought back (hoping the security will fall in value)

Covering the position

close the position in a short Sale by buying the security back

Broker

when BD is acting as an agent by assisting customer in buying/selling a security representing the customer in the transaction, they charge a commission for this service

Dealer

when BD acting as a principal by selling securities from the firm’s inventory to customers or buying securities from a customer for the dealer’s inventory, they are part of the trade (either buyer or seller) and profit between buy price and sell price – being a market maker/making a market

Settlement

process that ensures that both parties to a transaction receive what they are supposed to receive

Regular way settlement

industry standard for settlement is the next business day after the trade date, often seen as T+1

Cash settlement (same-day settlement)

requires delivery of securities from the seller and payment from the buyer on the same day the trade is executed, both parties must agree to it before trade takes place

Good delivery of physical certificates

must be endorsed by all owners who appear on the face of the certificate releasing their interest in it and signed exactly as the name appears, abbreviations or deviations are not permitted (aside from &, Co., and Inc.)

Stock/bond power

document that may be used instead of signing a physical certificate, most commonly used when certificates are mailed (should be sent in a separate envelope from the physical certificate)