Unit
- Primary market: Securities are created and sold for the first time through initial public offerings (IPOs) or bond issuances. Companies raise capital directly from investors, and investment banks underwrite the sale. This market provides funding for issuers and establishes the initial supply of securities.
- Secondary market: Existing securities are traded among investors without involvement of the issuing company. Stock exchanges like the NYSE and Nasdaq provide centralized platforms, while over-the-counter (OTC) markets handle less liquid instruments. Price discovery occurs through continuous buying and selling.
- Exchange-traded vs OTC: Exchange trading offers transparency, standardized contracts, and centralized clearing through a central counterparty. OTC trades are bilateral, customized, and carry higher counterparty risk. Many derivatives and bonds trade OTC, but post-crisis regulations push standardized products toward exchanges.
- Market structure evolution: Electronic communication networks (ECNs) and dark pools have fragmented liquidity. High-frequency traders provide liquidity but also raise concerns about market fairness. Regulators oversee market structure to prevent manipulation and ensure fair access.
- Trading hours and sessions: Regular trading hours vary by exchange. Pre-market and after-hours sessions allow extended trading but with lower liquidity and wider spreads. Global markets operate across time zones, enabling nearly 24-hour trading in currency and futures markets.
- Clearing and settlement: After a trade is executed, clearinghouses ensure both parties fulfill obligations. Settlement involves transferring ownership and funds typically T+2 for stocks. Central Securities Depositories hold securities in electronic form to facilitate efficient settlement.
- Liquidity and depth: Liquid markets allow large trades with minimal price impact. Market depth refers to the volume of orders at different price levels. Traders use limit order books to assess depth and anticipate short-term price movements.
- Market indices: Indices like the S&P 500 and FTSE 100 track broad market performance. They serve as benchmarks for portfolio returns and underly index funds and ETFs. Traders use index futures and options to hedge systematic risk.
- Order types: Market orders execute immediately at the current best price, while limit orders specify a price and may remain unfilled. Stop orders trigger a market order once a specified price is reached. Traders select order types based on their need for speed, price certainty, and control over execution outcomes.
- Market makers: Firms or individuals that continuously quote bid and ask prices, providing liquidity to the market. They profit from the bid-ask spread and must maintain fair and orderly trading under exchange rules. Market makers play a crucial role in facilitating transactions in less liquid securities and during volatile periods.
- Short selling: Borrowing shares to sell them with the expectation of repurchasing at a lower price. This practice provides liquidity and aids price discovery but carries theoretically unlimited risk. Regulatory constraints include uptick rules, locate requirements, and disclosure mandates to prevent abusive short selling practices.
- Margin trading: Using borrowed funds from a broker to buy securities, amplifying both potential gains and losses. The broker holds the securities as collateral and may issue a margin call if equity drops below the maintenance requirement. Traders must understand the risks, interest costs, and potential for forced liquidation.
Regulatory Requirement
Regulation: SEC Regulation NMS (National Market System)
Regulation NMS governs order protection, access fees, and market data dissemination in U.S. equity markets. It requires trading centers to execute orders at the best available price across all venues, ensuring fair competition and preventing trade-throughs. Traders must understand these rules to optimize execution quality.
Quick Revision
- Primary markets facilitate new issuances; secondary markets enable ongoing trading.
- Exchange trading offers transparency and central clearing; OTC markets provide customization.
- Market structure includes ECNs, dark pools, and high-frequency participants.
- Clearing and settlement processes ensure trade completion and reduce counterparty risk.
- Indices serve as benchmarks and underpin derivative products for hedging.