How Online Trading Works

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Electronic Trading or Computer Trading - whichever name you use for this - is how most financial markets work these days. All this is driven by huge computer systems that work very fast and very how does electronic stock trading work and handle huge volumes at large scales.

And that can only be achieved by using computers. While I am no expert in these and definitely have no idea how each of the many different electronic platforms are built, I have a basic idea of the components that need to go in to these. In this post I will try to briefly describe some of these and give you an idea of the complexity that is involved in these applications. What this will serve to do is help you understand how these systems work next time you hear about a flash crash or exchange failure.

As a note - if you already work in the financial domain or build some of these systems for a living - I might oversimplify or may be outright wrong in some cases - please point out any flaws in the comments and I will definitely make corrections.

An exchange is an organized market where the buyers and sellers come together to trade a set of agreed products under certain market guarantees provided by the market.

You can read more about exchanges on this Wikipedia article or on the internet. Before electronic trading become common, the buyers and sellers would gather and provide the prices where they were willing to buy or sell the product that is being traded.

According to the how does electronic stock trading work guidelines, these bids would be matched with one another and deals would be agreed. The exchange would then provide means to clear the trades and settle the deal.

If you have seen old movies about the stock markets, and if you had seen people gathering around in a circle and shouting prices and all - that was how it was.

All these are different components that need to work together and efficiently in order for the whole trading platform to work. If any one of these fails then the whole system will fail. The product is the core of all this. The exchange defines a product.

This product has a face value, sometimes a minimum size, conditions for delivery or settlements. Every participant who wants to trade in this product must clearly understand the product and associated terms. They must also understand the cost of owning or selling the product, the commissions if any and the means to settle or deliver the product. Since the trading is electronic in nature, all the data related to the product needs to be maintained and distributed to the participants electronically.

All this meta data, also called static data, is very essential for any market participant. Without this they will not be able to make an informed decision and trade on the product. Each participant maintains all the data they receive from the exchange and there are means for the exchange to communicate any changes and updates to all the participants. The participants are any one who wants to buy or sell the product. The participant needs a means to get on to the market, they need the product static data and they need a means to place and execute orders.

When a participant wants to get on to an exchange, they work with the exchange to provide necessary details and go through background checks so that they can be setup to trade on how does electronic stock trading work exchange. For electronic trading, the participants will not physically come to the market - they how does electronic stock trading work connect to the computer systems on the market.

They connect using different means - s0me co-locate in the exchange alongside the computer systems of the exchange so that they get the quickest access to the market. Others connect to the market using dedicated high speed lines.

The end goal for everyone is to be able to get on to the market quickly and faster than everyone else. The participants trade on the market as per the terms of the market - they are required to follow the rules set for the market and any violation is not taken lightly. In addition they are how does electronic stock trading work governed by the laws of the regulators of the country. Trading happens on a price - when the buyers specify that they want to buy by paying up to a certain price, called the bid priceand the sellers specify that they how does electronic stock trading work willing to sell for not less than a certain price, called the offer price, a market is created on the exchange.

This market has two kinds of aspects - the price and the order. The data about how does electronic stock trading work two are called the market data.

As more participants place orders on the market the price moves up or down and these movements of price are called price ticks. These price ticks are available to all the participants and also to others using various means like how does electronic stock trading work feeds or using public websites. The information about the price movements is very important for the participants because based on this they can make an informed decision on whether they want to buy or sell the product and at what price.

Just like the price is important, the participants also need to know about orders placed by others on the market. Unless you know how much of the product is being sold at a given price, how can you decide the size of your order? You need both the price and the size available on the market, your decision is not correct. In electronic trading, the exchange provides a specified format in which orders can be placed on the market - all participants know this format and place orders using this format.

Once the participants have placed orders on the market, there has to be a means of matching all these to create deals. Before electronic trading, the orders would be manually matched using the rules of the market. With the advent of computer based trading, all these rules for matching orders have been automated and the matching is performed very quickly.

There are systems that can perform order matching in matter how does electronic stock trading work microseconds. The matching engine is the core of the exchange and determines the performance of the market. How does electronic stock trading work is the most critical piece of the entire platform and must perform under the heavy volume without failing or missing any single order. These are built with various fail safe mechanisms and resiliency in order to guarantee that it is always available and can facilitate trading.

Once a deal is reached, accounts need to be kept and the deal information needs to be sent to both the parties involved in the deal.

There are dedicated systems on exchanges that facilitate sending these details to the participants. These could be real time feeds or end of day snapshots. These need to be capable of handling the volumes generated on the market. All these systems that I described might sound simple - but in reality there are various levels of complexity built in to these like security, validation, resiliency and many many rules and regulations that will govern the market.

In addition, to achieve the high speed and how does electronic stock trading work transaction volumes that are needed, these will be built with architectures that can withstand and perform a peaks loads. Once we have a trading platform comprising of all these, it starts working as as soon as the participants start placing orders. As more and more orders are placed and executed, the market grows and performs.

Since there is no way to artificially create a market, everything must come from the participants. If there are no participants then the market will fail. Even in a market where there are participants, they might be interested only in certain products. The best markets out there perform and how does electronic stock trading work by providing those products which everyone is interested in.

The huge electronic trading market is created when a large number of participants connect to these markets and place orders based on up to date prices and in large numbers. The participants use their own systems and calculations to determine which price is good. Crashes happen when a wrong price, a too low price or a price that can be taken advantage of is put on the market.

Crashes also happen when there is no balance between the number of buyers and sellers and one side is larger than the other. How does electronic stock trading work reactions from participants can also cause a crash. And of course there is the ever persistent threat of a computer system breaking down.

A good market will have means to identify all these issues before they happen and take corrective steps. All these systems are not some poorly done job that fails one day. They are large complex computer systems that work well and fail under very few circumstances. But more often they fail because of the conditions created by the participants rather then the hardware itself.

Electronic Trading - How does it work behind the scenes? Its the best thing - until it fails. How was it before electronic trading? So what are exchanges? All this was slow, took time and could handle only so much of volume. Hence the need for speed. The different things needed for trading What do we need if we want to trade a product?

We need a clearly defined product, which we understand along with all the terms attached to it We need participants in the market willing to buy and sell the product We need a price to be set on the product, or a price range to be defined for the product We need a mechanism to match the buyers and sellers and create deals Once how does electronic stock trading work deal is agreed, the records and accounts of the deal need to be maintained All these are different components that need to work together and efficiently in order for the whole trading platform to work.

Lets discuss each of these in details. The product The product is the core of all this. The participants The participants are any one who wants to buy or sell the product. The price and the order Trading happens on a price - when the buyers specify that they want to buy by paying up to a certain price, called the bid priceand the sellers specify that they are willing to sell for how does electronic stock trading work less than a certain price, called the offer price, a market is created on the exchange.

The matching engine Once the participants have placed orders on the market, there has to be a means of matching all these to create deals. The book keeping and settlement process Once a deal is reached, accounts need to be kept and the deal information needs to be sent to both the parties involved in the deal. Its not as simple as it sounds All these systems that I described might sound simple - but in reality there are various levels of complexity built in to these like security, validation, resiliency and many many rules and regulations that will govern the market.

Putting it all together Once we have a trading platform comprising of all these, it starts working as as soon as the participants start placing orders. Conclusion All these systems are not some poorly done job that fails one day.

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Electronic or scripless trading , sometimes called e-trading or paperless trading is a method of trading securities such as stocks , and bonds , foreign exchange or financial derivatives electronically. Information technology is used to bring together buyers and sellers through an electronic trading platform and network to create virtual market places. Electronic trading is in contrast to older floor trading and phone trading and has a number of advantages, but glitches and cancelled trades do still occur.

For many years stock exchanges were physical locations where buyers and sellers met and negotiated. Exchange trading would typically happen on the floor of an exchange, where traders in brightly colored jackets to identify which firm they worked for would shout and gesticulate at one another — a process known as open outcry or pit trading the exchange floors were often pit-shaped — circular, sloping downwards to the centre, so that the traders could see one another.

With the improvement in communications technology in the late 20th century, the need for a physical location became less important and traders started to transact from remote locations in what became known as electronic trading. Set up in , NASDAQ was the world's first electronic stock market, though it originally operated as an electronic bulletin board [ citation needed ] , rather than offering straight-through processing STP. By investment firms on both the buy side and sell side were increasing their spending on technology for electronic trading.

Traders also increasingly started to rely on algorithms to analyze market conditions and then execute their orders automatically. The move to electronic trading compared to floor trading continued to increase with many of the major exchanges around the world moving from floor trading to completely electronic trading.

While the majority of retail trading in the United States happens over the Internet, retail trading volumes are dwarfed by institutional, inter-dealer and exchange trading. However, in developing economies, especially in Asia, retail trading constitutes a significant portion of overall trading volume [8].

For instruments which are not exchange-traded e. US treasury bonds , the inter-dealer market substitutes for the exchange. This is where dealers trade directly with one another or through inter-dealer brokers i. They acted as middle-men between dealers such as investment banks. This type of trading traditionally took place over the phone but brokers moved to offering electronic trading services instead. Similarly, B2C trading traditionally happened over the phone and, while some still does, more brokers are allowing their clients to place orders using electronic systems.

Many retail or "discount" brokers e. Charles Schwab , E-Trade went online during the late s and most retail stock-broking probably takes place over the web now. Larger institutional clients, however, will generally place electronic orders via proprietary electronic trading platforms such as Bloomberg Terminal , Reuters Xtra , Thomson Reuters Eikon , BondsPro, Thomson TradeWeb or CanDeal which connect institutional clients to several dealers , or using their brokers' proprietary software.

For stock trading, the process of connecting counterparties through electronic trading is supported by the Financial Information eXchange FIX Protocol. Used by the vast majority of exchanges and traders, the FIX Protocol is the industry standard for pre-trade messaging and trade execution.

While the FIX Protocol was developed for trading stocks, it has been further developed to accommodate commodities, [9] foreign exchange, [10] derivatives, [11] and fixed income [12] trading. For retail investors, financial services on the web offer great benefits. The primary benefit is the reduced cost of transactions for all concerned as well as the ease and the convenience.

Web -driven financial transactions bypass traditional hurdles such as logistics. Exchanges typically develop their own systems sometimes referred to as matching engines , although sometimes an exchange will use another exchange's technology e.

Exchanges and ECNs generally offer two methods of accessing their systems —. From an infrastructure point of view, most exchanges will provide "gateways" which sit on a company's network, acting in a manner similar to a proxy , connecting back to the exchange's central system. Many brokers develop their own systems, although there are some third-party solutions providers specializing in this area. Some banks will develop their own electronic trading systems in-house, but this can be costly, especially when they need to connect to many exchanges, ECNs and brokers.

There are a number of companies offering solutions in this area. Many types of algorithmic or automated trading activities can be described as high-frequency trading HFT , which is a specialized form of algorithmic trading characterized by high turnover and high order-to-trade ratios.

From Wikipedia, the free encyclopedia. Not to be confused with E-Trade. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. September Learn how and when to remove this template message. Retrieved 29 October The Wall Street Journal. The New York Times. Retrieved July 8, Retrieved October 4, A Report on the 9.

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