takes a serious hit. On the other side of that coin, you also need to know how to get out when you’re in a winning or profitable position. When you’re trying to ride a trend all the way to the top, it sometimes starts bottoming out so fast that you lose some or possibly even all of your profits, causing you to end up in a losing position.
Trading is a skill that takes a long time to develop and is perfected only after you make mistakes and celebrate successes. Enjoy the roller coaster ride!
Chapter 2
Exploring Markets and Stock Exchanges
IN THIS CHAPTER
❯❯ Explaining the different types of markets
❯❯ Surveying the major stock exchanges
❯❯ Reviewing order basics
Billions of shares of stock trade in the United States every day, and each trader is looking to get his or her small piece of that action. Before moving into the specifics of how to trade, we first want to introduce you not only to the world of stock trading but also to trading in other key markets – futures, options, and bonds. In this chapter, we also explain differences and similarities among key stock exchanges and how those factors impact your trading options. After providing you with a good overview of the key markets, we delve into the different types of orders you can place with each of the key exchanges.
Introducing the Broad Markets
You may think the foundation of the United States economy resides inside Fort Knox, where the country holds its billions of dollars in gold, or possibly that it resides in our political center, Washington, D.C. But nope. The country’s true economic center is Wall Street, where billions of dollars change hands each and every day, thousands of companies are traded, and millions of people’s lives are affected.
Stocks are not the only things sold in the broad financial markets. Every day, currencies, futures, options, and bonds also are traded. Although we focus on stock exchanges in this chapter, we first need to briefly explain each type of market.
The stocks of almost every major U.S. corporation and many major foreign corporations are traded on a stock exchange in the United States each day. Today, numerous domestic and international stock exchanges trade stocks in publicly held corporations; moreover, the only major corporations not traded are those held privately – usually by families or original founding partners that choose not to sell shares on the public market. Forbes magazine’s top privately held corporations are Cargill, Koch Industries, Albertsons, Dell, and PricewaterhouseCoopers. Many of the large private corporations that are not traded publicly do have provisions for employee ownership of stock and must report earnings to the Securities and Exchange Commission (SEC), so they straddle the line between public and private corporations.
A share of stock is actually a portion of ownership in a given company. Few stockholders own large enough stakes in a company to play a major decision‐making role. Instead, stockholders purchase stocks hoping that their investments rise in price so that those stocks can be sold at a profit to someone else interested in owning a share of the company sometime in the future. Investors may hold the stock to earn dividends, as well. Traders rarely hold the stock long enough for dividends to be a primary decision factor in whether to buy a stock. Therefore, after the company’s initial sale of stock when it goes public, none of the money involved in stock trades goes directly into that company.
For the majority of this chapter, we focus on the two top stock exchanges in the United States: the New York Stock Exchange (NYSE) Euronext and NASDAQ (the National Association of Securities Dealers Automated Quotation system). We also introduce you to the world of electronic communication networks (ECNs), on which you can trade stocks directly, thus bypassing brokers.
Futures trading actually started in Japan in the 18th century to trade rice and silk. This trading instrument was first used in the United States in the 1850s for trading grains and other agricultural entities. Basically, futures trading means establishing a price for a commodity at the time of writing the financial contract. The commodity must be delivered at a specific time in the future. If you had a working crystal ball, it would be very useful here. This type of trading is done on a commodities exchange. The largest such exchange in the United States today is the CME Group. Commodities include any product that can be bought and sold. Oil, cotton, and minerals are just a few of the products sold on a commodities exchange.
Futures contracts must have a seller (usually the person producing the commodity – a farmer or oil refinery, for example) and a buyer (usually a company that actually uses the commodity). You also can speculate on either side of the contract, basically meaning:
❯❯ When you buy a futures contract, you’re agreeing to buy a commodity that is not yet ready for sale or hasn’t yet been produced at a set price at a specific time in the future.
❯❯ When you sell a futures contact, you’re agreeing to provide a commodity that is not yet ready for sale or hasn’t yet been produced at a set price at a specific time in the future.
The futures contract states the price at which you agree to pay for or sell a certain amount of this future product when it’s delivered at a specific future date. Although most futures contracts are based on a physical commodity, the highest‐volume futures contracts are based on the future value of stock indexes and other financially related futures.
Unless you’re a commercial consumer who plans to use the commodity, you won’t actually take delivery of or provide the commodity for which you’re trading a futures contract. You’ll more than likely sell the futures contract you bought before you actually have to accept the commodity from a commercial customer. Futures contracts are used as financial instruments by producers, consumers, and speculators. We cover these players and futures contracts in much greater depth in Chapter 19.
Bonds are actually loan instruments. Companies and governments sell bonds to borrow cash. If you buy a bond, you’re essentially holding a company’s debt or the debt of a governmental entity. The company or government entity that sells the bond agrees to pay you a certain amount of interest for a specific period of time in exchange for the use of your money. The big difference between stocks and bonds is that bonds are debt obligations and stocks are equity. Stockholders actually own a share of the corporation. Bondholders lend money to the company with no right of ownership. Bonds, however, are considered safer because if a company files bankruptcy, bondholders are paid before stockholders. Bonds are a safety net and not actually a part of the trading world for individual position traders, day traders, and swing traders. Although a greater dollar volume of bonds is traded each day, the primary traders for this venue are large institutional traders. We don’t discuss them any further in this book.
An option is a contract that gives the buyer the right, but not the obligation, either to buy or to sell the underlying asset upon which the option is based at a specified price on or before a specified date. Sometime before the option period expires, a purchaser of an option must decide whether to exercise the option and buy (or sell) the asset (most commonly stocks) at the target price. Options also are a type of derivative. We talk more about this investment alternative in Chapter 19.
Reviewing Stock Exchanges
Most of this book covers stock trading, so we obviously concentrate on how the key exchanges – NYSE and NASDAQ – operate and how these operations impact your trading activity.
