Operation of the Stock Exchange
Markets differ from one another in many ways, depending on the number of participants, the kinds of goods and services bought or sold, the national and local character of the market, and other factors. At the high extreme we have the New York Stock Exchange, a highly organized market with hundreds of specialized traders who buy and sell billions of dollars’ worth of stocks and bonds each day. At the other extreme is the corner grocery store, with a limited range of items and with a limited range of items and with sales barely large enough to support the individual who operates the store. But what these and other markets have in common is the fact that they are sites where information is transmitted among market participants, where bids and offers are made and accepted or rejected, and where sales or trades are concluded.
Such markets like the stock exchanges, the international gold market are highly organized and complicated. Ordinary citizens do not buy directly in these markets. They place their orders through brokerage houses which then relay them to floor brokers who then make buying and selling arrangements with other brokers on the floor of the exchange.
How do the stock exchanges work? In principle at least, things are fairly simple. You own stock in a company listed on the New York Stock Exchange, and you wish to sell your stock. To do so, you call the local office of a brokerage firm (such as Bache and Co., or Merrill Lynch, etc.-the “Thundering Herd”- or any of more than 100 such firms).You tell the firm to sell your shares either “at market” price, i.e. the best price the broker can get for the shares, or at a ”limit price”, that is, at a price you specify for the stock. For example, if the last transaction in your stock took place at $100 per share you might instruct the broker to sell your 100 at price of $ 102 or higher; $ 102 is the “limit” price for your shares.
The local office then teletypes your order to its brokerage office in New York City, which relays the order to its brokerage office in New York City, which relays the order to its representative on the floor of the New York Stock Exchange. That representative then goes to the post on the floor of the exchange where your stock is traded. At this position there is an individual called a specialist who deals in your stock. The specialist accepts buy and sell orders from the representatives of brokerage houses and other individuals who own seats at the exchange (to own a seat means an individual or firm has the right to buy and sell shares on the floor of the exchange). The specialist keeps a book where all buy and sell orders at various limit prices are listed. The specialist’s job is “to make a market” in the stocks he or she specializes in. That is to say, specialists buy and sell stocks on their own account, in order to trigger the buy and sell orders they have on their books at limit prices. They also execute the “market” orders they get.
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To illustrate the book of the specialist might look like this:
| Buy orders: | Sell orders |
| 100 shares at $98 | 100 shares at $99 |
| 250 shares at $97.25 | 150 shares at $99.25 |
| 300 shares at $97 | 200 shares at $100 |
Now an order comes in to the specialist to sell 100 shares “at market.” The specialist can execute this order by triggering the buy order at $98 per share; alternatively, the specialist might decide to buy the 100 shares personally, at, say, &98.25 per share. In any case, an order to buy and sell “at market” automatically gets executed at the best price the specialist can get for the shares being traded.
In a certain sense one can argue that specialists are in a preferred position relative to the market in the stocks they deal in. They know the demand and supply schedules for those stocks, as summarized in the limit orders on their books, and they can use the information to make money on their own account through their buying and selling activities. Consequently, the Securities and Exchange Commission (SEC) has rather detailed regulations concerning permissible actions on the part of specialists, and there are indications that at some time in the future, the SEC might rule that specialists’ order books are to be transmitted over the ticker tape just as prices are transmitted, so that all investors can take advantage of the information contained in the order book.
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