Basics of the Mechanics Behind Electronic Trading

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Basics of the Mechanics Behind Electronic Trading

Electronic trading is simple: Please sign in to your account. Choose whether you want to purchase or sell a security. The transaction is completed when you click your mouse or touch your screen. It’s basic and straightforward from the standpoint of an investor. Behind the scenes, however, it is a sophisticated operation supported by an astonishing variety of technology. What was formerly associated with yelling merchants and wild hand gestures is now associated with statisticians and computer programmers.

Key Takeaways

  • Setting up an account with a brokerage of your choosing, including supplying your contact and financial information—to permit electronic transactions between your bank and the brokerage—is the first step in electronic trading.
  • When you make an order, the complicated technology allows the brokerage to communicate with all securities exchanges wanting to complete deals, while those exchanges interact with all brokerages at the same time.
  • A automated matching engine executes a large number of deals per minute, and all work is stored up and available to investors, market makers, and government authorities for scrutiny.
  • The Depository Trust Company, a recordkeeper of all financial transactions conducted by US shareholders, protects and stores all information, ensuring that no information is lost.

First Step: Open an Account

The first step is to register with a brokerage business. This may be done online or by filling out and submitting the necessary documents. You will need to supply personal information, such as your name and address, so that the business can identify you, as well as some information about your degree of investing expertise. The brokerage business may then determine if the account you are looking for is acceptable. For example, if you have no expertise trading stocks but want to create a margin account that allows you to trade with borrowed money, your application may be declined.

You may also select electronic paths between your bank account and your brokerage account during the account-opening procedure, allowing money to flow in either direction. If you want to add additional money to your investable pool, just log in to your account and transfer it from your bank account to your brokerage account. Similarly, if your investments have produced profits and you need the funds to pay bills, you may transfer funds from your brokerage account to your bank account without making any phone calls. If you don’t have a bank account, you may open a money market account with a brokerage business and utilize it in the same way.

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These technological comforts need the use of computer equipment, such as servers, as well as human supervision to ensure that everything is correctly set up and functions as intended. When you are ready to trade, the technology needs grow much more sophisticated.

Electronic trading offers a safe marketplace for investors as well as industry-wide methods for preserving information, but it is not without risk: even a little malfunction may have far-reaching consequences.

Research Before Trading

Before you make an order, you should probably understand more about the security you intend to buy. Most brokerage websites include access to research studies to aid in your decision-making process, as well as real-time quotations that show how much the asset is trading for at any particular moment. The research reports are updated on a regular basis and are placed into the website as you visit them. Quotes are a significantly more complicated problem, as the system must monitor hundreds of data points related to stock prices and transmit that info to you promptly upon request.

How It Works

When you make an order, the infrastructure necessary to support the process grows. Order input and the diversity of options that it includes must be made easier by programming and technology.

First, you may choose from a variety of order kinds. Market orders are instantly executed. Limit orders may be configured to execute only at a certain price and within a specific time frame ranging from immediately to anytime within a month. These options must be accessible to all investors utilizing the system at the same time and must function in real-time.

The required buy price and share amount must be sent to the marketplace, which necessitates interaction between the computer system at the brokerage business where the order was placed and computer systems on the stock exchange where the shares will be acquired. The exchange’s systems must communicate instantaneously and concurrently with the systems of all brokerage companies, either offering shares for sale or looking to acquire shares.

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To make things even more complicated, the electronic interface must contain all exchanges (Nasdaq, NYSE, etc.) from which an investor may acquire an asset. The interplay of systems must complete transactions and provide the optimum trading price. To demonstrate to authorities such as the Securities and Exchange Commission (SEC) that the transaction was completed in a timely and cost-effective manner, the systems must keep a record of the transaction.

Every minute the market is open for business, the automated matching engine must process a large number of transactions and do it swiftly and flawlessly. Backup systems are required to ensure that investors have access to their accounts and may trade whenever the markets are open. Security regulators, like as the SEC, need access to the information held in investors’ accounts as well.

How Information Is Protected

That information is kept by the Depository Trust Company, a recordkeeper in charge of keeping track of all stockholders in the United States. The DTCC is a holding corporation that provides clearing, institutional transaction processing, settlement, and repository services via its subsidiaries. The DTCC’s repository services provide as a safety net, allowing investors to retrieve account information if the brokerage company in charge of executing the investor’s transactions goes out of business.

After the deal is completed, the transaction must be verified with both the buyer and the seller. To support trading in the wider marketplace, the data must be transmitted back out to the systems that gather and show prices to other market players.

Trading Records Kept

A record of the transaction must be kept in order for the data to be accessible for client statements and online access when customers log into their brokerage accounts. The system must record data for company activities like as dividends and capital gains on a continuous basis, not only to maintain the investor’s account balance up to current and correct, but also to allow tax filing. Massive amounts of data must be constantly monitored, recorded, and transferred.

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The system must also support periodic and regularly scheduled recurring transactions. Transfers to and from the investor’s personal bank account must be supported, as well as recurring transfers across accounts for account funding, bill payment, estate settlement, and a range of other operations.

Risks

Electronic trading is an essential component of financial markets. Everything from technical problems to blatant fraud may disrupt the smooth and efficient operation of such markets, costing brokerage companies money and bringing the financial system’s reputation into doubt. Minor flaws, such as the “flash crash” of May 6, 2010, may cause chaos. The flash crash was a quick trading snafu that led the Dow Jones Industrial Average to drop 600 points in less than 5 minutes. Over $1 trillion in market value has vanished. To set things right and make investors whole, 21,000 contracts were canceled—all because of a single malfunction created by a futures order made on a brokerage firm’s computer system, which prompted panic trading to spill over into the equities markets.

The Bottom Line

Electronic trading is very sophisticated and extremely rapid. It provides rapid access to a diverse range of assets and marketplaces. The data support comprises all of the reporting features required by investors as well as all of the data required by authorities. It provides a safe environment for personal account information as well as an industry-wide repository to guarantee that no data is lost. Despite its huge trade volume, the system is quite dependable. It’s a contemporary technical wonder, and you can use it for a few bucks each deal.

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