Exchange Market Characteristics

CFA Level 1 - Securities Markets

The main characteristics of exchange markets can be classified into:

1.Exchange membership
2.Types of orders
3.Market makers

1. Exchange Membership

In the U.S., the listed securities exchanges classify memberships as:

-Specialists

Specialists are the market makers for stocks, controlling the limit book and posting bid and ask prices.

-Commission Brokers

Commission brokers are employees of a firm that is a member of the exchange. The commission broker buys and sells shares for the clients of its firm. 

-Floor Brokers

Floor brokers function much like commission brokers buying and selling shares. Unlike commission brokers who are employees of member firms, however, floor brokers are independent and aid commission brokers when they become too busy.

-Registered Traders

Registered traders are members that buy and sell for their own account. They help to provide liquidity. Because they are independent, however, the exchange places limits on how they trade.

2. Types of Orders

An order on an exchange can be classified as follows:

 -Market Order

A market order is a basic order to buy or sell a security at the best available price. For example, a client places an order to buy 100 shares of Newco; the client expects/wants the best available price for buying those shares.

-Limit Order

A limit order places a specific price at which a transaction is executed. These orders typically have a set time horizon in which the limit order can be executed. For example, Newco's stock is trading at $50. A client places a buy limit order to purchase shares at $45. The transaction will thus be executed when the shares reach $45, if they do. Otherwise, the order will expire in the allotted time.

-Short Sale Order

A short sale order is an order to sell shares that a client does not own. As a result, the trader must borrow the stock, sell it, and then buy the stock again to replace the shares he borrowed. For example, a client wants to sell 100 shares of Newco short at $45. The trader must borrow 100 shares, sell the 100 shares and then purchases the shares to replace the ones he borrowed. A client may do this if he believes shares of the respective company will decline below the price at which the shares were sold short. 

-Stop Loss Orders

Stop loss orders are placed in order to prevent losses on shares below a specified share price. For example, an investor bought shares of Newco at $50. The shares appreciated to $100. The investor is interested in protecting some profit on the shares of Newco in case the price starts declining. This investor may place a stop loss order on the shares of Newco at $80. If Newco's shares decline to $80, the stop loss order would be executed, protecting some of the investor's profit.

Whether you use this strategy for your own or for a client's portfolio, stop loss orders are essentially a simple but powerful tool to help implement a stock-investment strategy. Find out more in the article called The Stop-Loss Order, Make Sure You Use It

3. Market Makers

Market makers facilitate the trading in a stock, buying and selling stock from their own accounts in order to maintain orderly trading and provide liquidity in a stock if it is needed. Additionally, the market maker manages the limit order book where both limit and stop orders are recorded. In the U.S. exchanges, the market maker is known as a specialist

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