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Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
Introduction To Trading And Order Types
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Introduction To Trading And Order Types

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These groups of Lessons are specifically designed for MBA candidates and Finance Major Students to give them a quick and detailed introduction to Trading Concepts. This document is intended to serve …

These groups of Lessons are specifically designed for MBA candidates and Finance Major Students to give them a quick and detailed introduction to Trading Concepts. This document is intended to serve as an introduction to basic trading concepts and order types.

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  • Good demonstration, but your document has wrong calculation for spread (MSFT). It should be 0.94
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  • 1. INTRODUCTION TO TRADING TERMS ORDER TYPES TRADING 101 Abstract These groups of Lessons are specifically designed for MBA candidates and Finance Major Students to give them a quick and detailed introduction to Trading Concepts. This document is intended to serve as an introduction to basic trading concepts and order types. Copyright © 2010 Prashant Ram All rights reserved 1 Lessons in Trading: Introduction to Trading and Order Types
  • 2. CONTENTS TICKER 3 BID, ASK AND SPREAD 3 GOING LONG , SELLING SHORT 3 Long Position (Going Long) 3 Short Position (Selling Short) 4 TYPES OF ORDERS 4 Market Order 4 LIMIT ORDER 5 STOP ORDERS 5 STOP LIMIT ORDERS 6 TRAILING STOP ORDERS 7 TIME THE MARKET 8 AON 8 FOK 8 IOC 8 GTD 9 GTC 9 Copyright © 2010 Prashant Ram All rights reserved 2 Lessons in Trading: Introduction to Trading and Order Types
  • 3. TICKER Each stock on the Stock exchange has a ticker symbol. For example Microsoft has a ticker symbol MSFT. Exercise: Go to http://finance.yahoo.com and type in MSFT in the ticker and get the current stock price. BID, ASK and SPREAD Each stock has a person (dealer/specialist) from whom the stocks can be bought and to whom stocks can be sold. A broker interacts with dealers and buys or sells stocks from dealers. Think of a dealer as a shopkeeper who has items for sale and is also ready to buy items from you. Each stock has a stock price which is an average value based on the BID and ASK price. The BID price is the price at which a dealer/specialist is willing to BUY the stock. The ASK is the price at which the dealer/specialist is willing to sell the stock. The actual current price of the stock is the (weighted) average of the BID and ASK price. Example: Lets say the current BID price of MSFT is $24.09 And lets say the current ASK price is $25.03 This means the dealer is willing to BUY stocks from the broker @ $24.09 And he is willing to SELL it to the brokers @ $25.03 (note: the BID price is always less than the ASK price, this is because the dealers are willing to SELL at the higher price) The current stock price may be reflect on yahoo as $25.00, which is derived from the weighted average of the BID and ASK. The difference between the BID and ASK is called the SPREAD. SPREAD = ASK – BID = $25.03 – $24.09 = 0.04 MSFT Current Price: $25.00 BID: $24.09 ASK: $25.03 SPREAD: 0.04 GOING LONG, SELLING SHORT There are two ways you can make money in the stock market Long Position (Going Long) Taking the long position means buying a stock, holding it and selling at a later time when the stock price goes up. Example: Copyright © 2010 Prashant Ram All rights reserved 3 Lessons in Trading: Introduction to Trading and Order Types
  • 4. You buy 1000 shares of GOOG today @ $300 each. And hold on to it for 6 months. Say in 6 month you decide that now is a good time to see GOOG since the price of GOOG is $350 each. So you sell GOOG @ $350 each thereby making a profit of $50 * 1000 = $50,000 You will take a LONG POSITION if you are expecting the price of the STOCK to RISE in the future. Short Position (Selling Short) You take a short position when you feel the price of the stock is going to fall in the future. Example: Say the current price of XYZ stock is $100 each, and you think that in 3 months the price of the stock is going to fall. In such an event you can still make money in the market by taking the short position. This is what you would do 1. You will BORROW (say) 1000 shares of XYZ from your broker @ $100 each. 2. You will immediately SELL the 1000 shares, @ $100 each 3. In 3 months the price of the stock falls to $70 each, you now BUY back 1000 shares of the XYZ stock @ $70 each. 4. You return the 1000 BORROWED stocks to your broker. 5. Thus, you have earned a neat profit of 100-70 = $30 per share * 1000 shares = $30,000 You will take the SHORT POSITION if you are expecting the price of the STOCK to FALL in the future. TYPES OF ORDERS Market Order A market order is an order to BUY or SELL a stock at the current market price. So say you put in a MARKET order to buy 1000 shares of MSFT. - MKT (BUY, 1000) This order will be executed @ the current ASK price of $25.03. If you put in a MARKET order to sell 1000 shares of MSFT - MKT (SELL, 1000) This order will be executed @ the current BID price of $24.09 Here is how the process actually works. The person (say John Smith) wants to BUY 1000 shares of MSFT at the current market price. He calls up his broker and lets him know. The broker then contacts the dealer/specialist who is carrying the MSFT stock and find out what’s the best (lowest/cheapest) price he can BUY MSFT stock at. This min price that the broker can BUY the stock is the minimum price that the dealer is willing to sell the stock (i.e. the ASK price). Hence the market BUY order is executed @ $25.03. Copyright © 2010 Prashant Ram All rights reserved 4 Lessons in Trading: Introduction to Trading and Order Types
  • 5. Similarly, a market SELL order is executed at the highest price that the broker can obtain for the stock (Think about when u want to sell your car, you want to sell it at the highest possible price you can get for it). The best price the broker can obtain is the highest price the dealer is willing to pay for the stock (i.e. the BID). So a market SELL order is executed @ $24.09. (note the BID and ASK prices change every millisecond for some stocks. So the marker order is executed at the market price when the order actually reaches the market floor. Thus say when John Smith placed his market BUY order with his broker the ASK was $25.03, then by the time the broker contacted the dealer the ASK changed to $25.05, in this case the market order is executed @ $25.05 (i.e. the market price of the stock when it reaches the market floor) LIMIT ORDER A limit order is an order to BUY or SELL a stock at a specified price or better. Thus for a LIMIT BUY order we want to buy at price X or lesser and for a LIMIT SELL order we want to sell at price X or higher. Think of it when you want to sell your car. When you want to sell your car say you want at least $2000 for it. So you want to SELL it at $2000 or more. (This is similar to LIMIT SELL) If you want to buy a washing machine, and your budget is $500, you scout the market to buy one for $500 or lesser. So you want to buy it at $500 or lesser. (This is similar to LIMIT BUY) Example: MSFT Current Price: $25.00 BID: $24.09 ASK: $25.03 SPREAD: 0.04 Say you want to BUY 1000 shares of MSFT @ $25.02 or better. You put in a LIMIT BUY order for 25.02. (note: the current ASK for MSFT is $25.03) - LIMIT (BUY, 1000, $25.02) i.e. LIMIT (BUY, <no of shares> , <limit price> ) Since the dealer is willing to sell MSFT only at $25.03 your LIMIT order will NOT execute, until the ASK of MSFT drops below $25.02 Say you want to SELL 500 shares of MSFT @ $25.02 or better. You put in a LIMIT SELL order for $25.02. (note: the current BID for MSFT is $24.09) - LIMIT (SELL, 500, $25.02) i.e. LIMIT (SELL, <no of shares> , <limit price> ) Since the dealer is not willing to pay more than the BID ($24.09) your LIMIT order will NOT execute, until the BID of MSFT goes above $25.02 STOP ORDERS A stop order is an order that is TRIGGERED when a prespecified price is reached. Once the prespecified price is reached the order becomes a regular market order. STOP LOSS ORDER (SELL STOPs) Copyright © 2010 Prashant Ram All rights reserved 5 Lessons in Trading: Introduction to Trading and Order Types
  • 6. A SELL STOP ORDER is and order that is converted to a regular MARKET SELL ORDER when the trigger price is reached. - STOP LOSS ORDER (<trigger price>) For example we put a SELL STOP ORDER (also called a STOP LOSS ORDER) @ $20.00 for MSFT. MSFT Current Price: $25.00 BID: $24.09 ASK: $25.03 SPREAD: 0.04 In this case if the price of MSFT falls below $20.00 then the STOP LOSS order is triggered and the stocks are sold at the then available market price. The purpose of STOP LOSS orders is to protect against sudden price drops. This way the traders losses are limited to $5 per stock (i.e. $25 – stop price). Even if the price of the stock continues to fall the trader exits the market at $20.00 so he is protected against further losses. STOP ORDERS are used when LONG Position is taken, cause in long position we are hoping that the stock prices go up to make a profit. BUY STOPs A BUY STOP ORDER is a reverse of STOP LOSS ORDERs and are used for unexpected RISE in prices. BUY STOP orders are used while taking SHORT position. (if you remember short positions are taken when we are expecting stock prices to fall, so any unexpected RISE in stock price can be detrimental) Say we put in a BUY STOP ORDER at $30 on MSFT (and we hold a SHORT position on MSFT), when the price of the stock crosses $30, we start BUYING THE STOCK. BUY STOPS are extremely RARE. STOP LIMIT ORDERS A stop limit order is just like stop order. However when the trigger price is reached the order is converted into the LIMIT ORDER (not market order). So say we place a STOP LIMIT ORDER on MSFT @ $20, limit price $20. Thus if the stock price falls below $20 then the order is converted into a Limit SELL order @ $20. STOP LOSS LIMIT (<trigger price>, <limit price>) Note: As indicated previously a regular STOP LOSS order is converted to a MARKET order when trigger price is reached. A STOP LOSS LIMIT ORDER is converted to a LIMIT order when the trigger price is reached. The following example illustrates the difference between the two. MSFT Current Price: $25.00 BID: $24.09 ASK: $25.03 SPREAD: 0.04 Consider the following cases 1. STOP ORDER (SELL, $20) 2. STOP LIMIT ORDER (SELL, $20, $20) 3. No STOP orders Copyright © 2010 Prashant Ram All rights reserved 6 Lessons in Trading: Introduction to Trading and Order Types
  • 7. Now lets say the stock price of MSFT starts falling and reaches $20, and is continuing to drop 1. When $20 is reaches the STOP ORDER (SELL, $20) is triggered and a market order market to SELL the shares at the current market price is triggered. Since the price of the stock is continuously falling by the time the market order actually reaches the market floor the market price of the stock may be $19.90. IN this case the stocks are sold at the current market price of $19.90 2. When $20 is reaches the STOP LIMIT ORDER (SELL, $20) is triggered and a LIMIT order with specified price of $20 is triggered. Now since the price of the stock is continuously falling by the time the LIMIT order reaches the market the current market price of the stock may have fallen to $19.90. In this case the LIMIT order will NOT execute, and stocks will not be sold. Thus we see that STOP LIMIT ORDERS may not always execute like STOP ORDERS since the market prices may be out of the limits 3. Lets assume the stock price continues to drop to $15. Now if no STOP ORDERS were put then the trader would experience a loss of $25 - $15 = $10. Putting the STOP ORDERS at $20 allows the trader to quit the downward moving trend and his losses are limited to $25 - $20 = $5. TRAILING STOP ORDERS A trailing stop order is a stop order where the stop price is not fixed, but trails the stock price. For example for a SELL ORDER we can fix the TRAILING STOP ORDER to 3 points below the stock price. In this case if the stock price rises the trigger price (STOP price) will always be 3 points below the stock price. However if the price of the stock falls the trigger price remains firm at the highest point it reached. MSFT Current Price: $25.00 BID: $24.09 ASK: $25.03 SPREAD: 0.04 1. The current STOP PRICE is thus @ 25.00 – 3 = $22.00 2. IF the stock price starts rising the trailing stop trails the rising price. Thus if the price rises to $27.00 the new STOP PRICE is 27-3 = $24.00 3. Now lets assume that after rising to $27.00 the stock price starts falling, in this case the STOP ORDER remains firm. So if the stock price is now $26.00, the stop order does NOT trail DOWNWARD movement and remains fixed @ $24.00. (NOTE: FOR SELL ORDER the STOP order trails ONLY RISING PRICES and remains at the highest point it reaches.) 4. Say the stock price continues to fall and falls to $24.00, in this case the TRAILING STOP is triggered. Depending on if it’s a TRAILING LIMIT STOP or just a TRAILING STOP it will either generate a LIMIT order or market order respectively when the trigger price is reached. Copyright © 2010 Prashant Ram All rights reserved 7 Lessons in Trading: Introduction to Trading and Order Types
  • 8. Market Order Limit Order Stop Order Stop Limit Trailing Stop Order Order Executed at Executed at Triggered Just like Stop The TIGGER current market prespecified when TRIGGER order, prices are NOT price price or better price is triggered when fixed prices but crossed. When TRIGGER price “trail” based trigger price is is crossed. on price reached order However when movements. is converted to trigger price is MARKET Order reached order is converted to LIMIT Order Purpose is to Purpose is to Used to limit Used to limit Used to limit obtain speed of obtain a good losses and losses and losses and order price, speed is protect against protect against protect against execution, secondary sudden price sudden price sudden price price of the drops drops drops, while share is adapting to secondary positive market movements TIME THE MARKET Generally when a broker places an order with a dealer/specialist it is not necessary that the entire quota of order is fulfilled. Several times the order can be partially filled AON An AON (all or none) order will remain at the exchange until the entire quantity is available to be executed or the order is cancelled. Example: You transmit an AON Market BUY order for 1000 shares of XYZ and have the time in force set to DAY. The order works throughout the day, waiting to execute until the entire quantity becomes available. If this doesn't happen, the order is cancelled at the close of the market FOK FOK (Fill or Kill) order must execute as a complete order as soon as it becomes available on the market, otherwise the order is canceled. Example: At 10:00 AM Tuesday, you transmit an order to buy 10 March04 55 calls of XYZ. You want the entire order to fill right away or be canceled. You select FOK as the time in force. IOC That portion of the IOC order that is not executed immediately after it becomes available on the market will be cancelled. Copyright © 2010 Prashant Ram All rights reserved 8 Lessons in Trading: Introduction to Trading and Order Types
  • 9. Example: At 10:00 AM Tuesday, you transmit an IOC BUY limit order for 1000 shares of stock XYZ. The order is received and becomes available for trading at 10:00:15. Five hundred shares execute immediately at your limit price. The remainder of the order (500 shares) is cancelled. (NOTE: The difference between FOK and IOC orders are that FOK orders have to be filled in their entirety when they hit the market (else the whole order is cancelled) UNLESS OTHERWISE SPECIFIED ALL OPEN ORDERS ARE CANCELLED AT THE END OF THE DAY. Thus unless otherwise specified no orders go beyond a DAY and are DAY Orders. Following are examples of other orders that extend over a day. GTD GTD (good 'til date) is a time in force that lets you select an expiration date and time through which a submitted order will remain active. To use, select GTD as the time in force. Two new fields, "Exp. Date" and "Time" will appear next to the Time in Force field. Set the good 'til date using the format YYYYMMDD. Set the Time using the format HH:MM:SS. To use a time zone other than your local zone, enter the time zone abbreviation following the date. Use EST for Eastern Standard Time, PST for Pacific Standard Time, and GMT for Greenwich Mean Time. Example: You can define any order type as good 'til date/time using the GTD time in force. This ensures that your order will remain active up until the close of market on the date you specify, or if you also specify a time, up until the date and time you specify. When you create an order, select GTD from the Time in Force field. In the Exp. Date field that displays, you enter the date through which you want the order to work. If desired, you can also enter a specific time in the Exp. Time field. GTC A Good-Till-Canceled order continues to exist till it is executed or cancelled by the initiator. All GTC orders are automatically cancelled after 90 days irrespective of whether they are filled or not. About the Author Prashant Ram is a Senior IT Executive based in New York and Lead Business Analyst working on Wall Street. He has over 10 years of diverse experience in IT consulting with extensive experience in Strategic IT Management, Business Development and Financial Trading systems. He is the Author of various online resources with topics ranging from Financial Trading Systems, Project Management methodologies and Strategic Managements, to Emerging Ideas in Business Development for Global Organizations and India's continued growth as an economic power house in the next decade. You may view the complete Lessons in Financial Trading Systems online at: http://monstertrading.weebly.com Copyright © 2010 Prashant Ram All rights reserved 9 Lessons in Trading: Introduction to Trading and Order Types

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