Stock Market Trading Mechanics and Processes

Posted on Mar 31, 2025 in Business Administration and Management (BAM)

Market Types and Order Priority

Markets are normally order-driven (where supply and demand set the price). However, some specific stocks and markets are still quote-driven (where a trader sets the price). It is an open and semi-transparent marketplace based around a rolling auction model.

  • Price Priority: The best-priced orders (highest buys, lowest sales) have priority in the order book.
  • Timing Priority: When prices are the same, the earlier an order is entered into the order book, the higher the position it will occupy.

Market orders will always be executed against the best available price on the other side.

Daily Trading Phases

Pre-Opening and Opening Auction (8:30 AM – 9:00 AM)

This is a 30-minute pre-opening period. In this window, traders can enter buy and sell orders into the system before the market officially opens. During this time, these orders are collected but not yet matched.

  • The system determines the equilibrium price, which is the point where the greatest volume of buyers and sellers match (supply equals demand). This price is calculated to ensure fairness and efficiency.
  • Once the system starts calculating the equilibrium price, no new orders can be entered. This period ensures no disruptions or price manipulation occur.
  • The auction has a random end that can vary by up to 30 seconds. This randomness helps prevent manipulation.
  • Any unmatched orders that could not be executed at the equilibrium price remain in the system. These orders then form the basis of the open session order book.

Open Market (9:00 AM – 5:30 PM)

During this time, orders can be entered, modified, or cancelled. When buying and selling orders coincide at a determined price, the system matches them, and the trade occurs. The order book is semi-transparent: all participants can see the orders but not the identity of the person behind them. Brokers may hide the full quantity of an order.

Market Close and Closing Auction (5:30 PM – 5:35 PM)

There is an additional closing auction which follows the same rules as the pre-opening auction. The resultant price of the closing auction is the closing price for each individual stock that day. The closing auction was established in 2000 to provide a fairer closing price fixing mechanism.

  • If fewer than 500 shares trade during the closing auction: The closing price will be the price closest to the weighted average of the last 500 shares traded in that session.
  • If fewer than 500 shares are traded throughout the entire day: The closing price remains the same as the previous day’s closing price.

Special Trading Systems

Fixing System for Less Liquid Stocks

This system is designed to facilitate trading for smaller companies with less market activity. Here’s a detailed breakdown:

  • Purpose: Smaller companies often experience low trading volumes, leading to little market activity throughout the day. To address this, the system uses two auctions instead of continuous trading.
  • First Auction: Takes place at 12:00 PM (noon). However, traders can enter orders into the order book starting from 8:30 AM.
  • Second Auction: Occurs at 4:00 PM (16:00). Orders are counted starting from the close of the first auction. The second auction price becomes the closing price for the day.
  • Minimum Volume for Price Setting: To establish a closing price in the fixing market, the minimum volume required is 200 shares.

Block Market

The Block Market is a parallel trading system for executing large-volume trades (“Put-throughs”). Here’s a quick summary:

  • Purpose: It allows the trading of large blocks of stock outside the regular market.
  • Eligibility: All stocks listed on the S.I.B.E. (the primary market) can trade in this system.
  • Trading Hours: Operates from 9:00 AM to 5:30 PM.
  • Minimum Volume Requirement:
    • Minimum trade sizes vary:
    • From €15,000 for illiquid stocks.
    • Up to €650,000 for highly liquid stocks, with a sliding scale in between.

Corporate Actions and Market Concepts

Initial Public Offering (IPO)

An IPO is the public sale of shares in a company. It can involve the sale of existing shares, the sale of new shares (to raise fresh capital), or a combination of the two.

Timing and Phases:

  • Communication to the Regulator and registry of the prospectus.
  • Management Roadshow to explain the business to investors.
  • Indications of demand.
  • Price fixing.
  • Allocation of shares (likely pro-rata depending on demand).
  • Shares start trading.
  • Payment and settlement of IPO shares.

IPO Participants:

  • Global Coordinator: The controlling bank/broker that sets supply, gauges demand, and is responsible for price fixing and distribution of shares.
  • Managers & Co-Managers: Banks/brokers that organize marketing and sell the shares to their clients.
  • Underwriters: Guarantee (for a fee) the success of the transaction by promising a minimum income to the issuing shareholder. They will buy any unsold shares directly.

Short Selling

Short selling is designed to allow investors to make money when share prices decline, not rise.

  • Custodian banks “lend” shares to investors (principally hedge funds) for a rental fee.
  • These shares can then be sold in the market, with the hope that the share price will decline and they can be bought back cheaper.
  • The short seller makes (or loses) on the price difference between the sale and repurchase. Borrowed shares are then returned.

Losses can be exponential, unlimited, and potentially unjustified by any fundamental reason.

Capital Types

  • Floating Capital: Shares that are open to free market transactions (actively traded).
  • Captive Capital: Shares held as permanent holdings or owned by Board Members. These are not actively traded.

Companies with higher free float percentages receive a higher weighting in equity indices. Companies with lower free float have reduced weightings to reflect their limited market liquidity.

Secondary Market Offerings

This involves the issue of new shares by an already listed company, following a process similar to an IPO.

  • Shares are typically offered at a discount to attract demand and are used to raise funds for new investment.
  • Existing shareholders often receive preferential rights to buy the new shares, and these rights may be traded separately.

Stock Splits

Management may decide on a “split” when the share value has risen significantly, making individual shares more accessible to buy. This makes no difference to the overall value of the company, as the share price should adjust by the same multiple as the split.

The inverse is a Contra-split (or reverse stock split).

Dividends

The dividend is the part of a company’s profit that management decides to distribute proportionally among all shareholders.

  • Dividend payment is completely voluntary and subject to management decisions and policy.
  • It may be paid in cash or in new “bonus” shares in the company.

Share Buybacks

A share buyback is also considered part of shareholder remuneration. The company uses excess cash to buy its own shares from the market and cancel them. This can increase the price of the remaining stock, thus adding value for shareholders.