Thread: Can't quite get my head around stocks...

I'm an economics student with some interest in trading, and there is one concept pertaining to stock markets I can't quite figure out and I am unable to find an answer for it on the internet.

How are stock (and other derivatives) trading transactions able to occur instantaneously? In conventional, non-electronic trading, a buyer must be connected to a seller for a trade to occur, but in the world of electronic trading, as I have learned through trading simulators, this is not necessarily the case.

Another implication of this, is that in the event of a stock bubble being burst and all the shareholders are selling their shares- who the hell are they selling them to? Is the bourse holding a reserve of shares in each company listed so that it can connect buyers to sellers whenever they come about?

How is it that I can buy X amount of shares whenever I want, without there being someone willing to sell the same amount at the same time?

I recognise this is probably a really dumb question, but I'm losing sleep over this- any help would be greatly appreciated.

How?.....It really comes down to liquidity and price. As you probably already know the electronic markets are handled by complex algorithms that connect buyers with sellers. When you route an order generally you will set a price you are willing to buy/sell at ie. a limit order. That order is routed to an exchange. Most platforms allow you to select which exchange or, as most of us probably do, to "best". The exchanges compete for order flow from the brokerages so it behooves them to get you the best fill they can as fast as possible. There isn't "always" a buyer or seller as you describe for the price you may want. Market makers can provide liquidity by taking the other side of most of what you do if they can hedge off the risk with options or futures or stock...basically arbitraging the spread. But as you may have noticed in today's electronic markets many stocks, options and futures are trading a penny or two wide...so there isn't much juice there. Markets makers have an obligation to provide liquidity...but as you suggested if/when there is a crash and the buyers step aside the price can make a huge move very quickly.

Don't expect that there will always be someone to take the other side of your trade. With a lot of the high frequency traders gone we have seen a marked decrease in liquidity. I think this was especially noticeable in the little mini crash we had a month or two ago. If you watched the tape action on something like SPY you would have seen the problem. Options markets that were normally a penny or 3 wide at/near the money became 2$ wide at some points....so there was no way to get a fill to hedge off risk unless you were willing to give up a dollar or so. Also at the same time capital requirements to hold margined positions went through the roof (as banks/brokerages etc needed to make sure there was enough money to cover the risk)...so many had to liquidate at whatever price they could get. Meaning there were more people competing for fills on the sell side and buyers were backing off as it got harder and harder to hedge off the risk.

I guess the short/simple answer to your question is that we put in an order to buy or sell. Most of us use a limit order. Means we set a price we want filled at. If someone is willing to hit that price we both get filled....but if not...the order just sits until someone is willing to buy/sell at that price. So whether or not you get filled quickly really is a function of price. If you put in a "market order" you will instantly hit every bid or ask available until the order fills...which can be disastrous in some cases even in highly liquid markets if there is even a glitch in liquidity for a second.