Example of a Trade

In an example of a trade, an investor wanting to buy 200 shares—also known as two round lots, of 100 shares each—of IBM stock will telephone or e-mail the order to a brokerage firm. This communication is normally made to an individual called a stockbroker. The investor might desire to buy the shares at the market, or current, price. On the other hand, the investor may choose to pay no more than a set amount per share. The brokerage firm then contacts one of its floor brokers at the NYSE, the exchange on which IBM stock is traded. The floor broker then goes to IBM’s stock post—that is, the particular spot on the trading floor where IBM stock is traded. Here other floor brokers will be buying and selling the same stock. The activity around the post constitutes an auction market with transactions typically communicated through hand signals. The most important person at the post is a broker-dealer called a specialist. The job of the specialist is to manage the auction process. The specialist will actually execute the trade and inform the floor broker of the final price at which the trade has been executed. For this service, the investor will pay the original broker a commission, either as a flat fee or as a percentage of the purchase price.

The price of a stock depends on the market forces of supply and demand. With companies issuing only a limited number of shares, price is determined by demand. An increase in demand will raise the price whereas a decrease in demand will lower the price. Normally the demand for a particular stock depends on expectations regarding the profits of the corporation that issued the stock. The more optimistic these expectations are, the greater the demand will be and, therefore, the greater the price of the stock.

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