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Understanding how the share market works

Whether you’re starting out or have some trading experience, having a basic understanding of how the share market works can provide an important advantage. This guide covers many of the fundamentals, plus some of the anomalies of the market.

01

Primary and secondary markets

The share market is an everyday term for where securities such as shares, bonds and other assets are issued or traded (bought and sold). There are two types of markets:

  • Secondary market – this is where previously-issued securities are traded and is the main market for buying and selling. The secondary market is generally referred to as the 'stock exchange'.

02

Basics of trading on the stock exchange

The stock exchange is an organised market for publicly available securities and connects investors wanting to buy (bids) and investors who want to sell (asks). Stock exchanges keep a record of security values including how they change over time.

The New Zealand stock exchange is called the NZX and the Australian stock exchange is called the ASX.

To buy and sell shares on the stock exchange (called 'trading') you'll need to place an order through a stock broker - this is a company licensed to give investors access to the stock exchange. Some brokers offer advice, while others, like ASB Securities offer online share trading services for investors who'd like to make their own share trading decisions.

The difference between an order and a trade

  • The term order is used to describe an instruction to buy or sell a specified quantity of securities and a specific price (either a limit price or a market price)
  • The term trade is used once an order instruction is filled/executed in the market i.e. someone meets the conditions of your order and the transaction occurs (a buy order is matched with a sell order)
  • An order can trade in multiple parcels, so for one order you could have multiple trades depending on what is available in the market. For example, if you place an order to buy 100 shares, you could have up to 100 trades, if it traded in parcels of 1 share (although this is quite unlikely).

It matches buyers with sellers

When you place an order to buy shares, it is fed into a system that puts you ‘on the market’ as a buyer. Once on the market, your order will trade (this is referred to as ‘execute’) when your order matches with sellers willing to sell at or below the price you’ve offered.

03

Pricing

Quoted prices

There are generally three standard prices that are quoted on the share market:

Buy

This is the highest price buyers are willing to pay to buy shares.

Sell

This is the lowest price sellers are willing to receive to sell their shares.

Last

This is the last traded price which is simply a historical reference to the price that the stock last traded at.

Pricing options

When placing an order to buy or sell shares, you have a choice of two main pricing options:

Market price

This is the price that’s set by the market, at the time you buy or sell. So if you’re buying, you’ll buy at the price that the seller at the top of the queue wants to sell for. If you’re selling, you’ll sell for the price that the buyer at the top of the queue wants to buy for.

Because of this, the market price can change rapidly – sometimes in the time it takes to place your order. You don’t need to queue to place a market-price order – the trade generally happens straight away – but you can only place a market-price order during market trading hours.

Limit price

With a limit-price order, you set the maximum amount you’re willing to buy at or the minimum you are willing to sell at. (For example, if your limit price for buying a share is set at $1.15, your order will only trade if a seller is willing to receive $1.15 or less per share). You can place a limit-price order at any time.

Remember:

It’s important that when looking for the price that is relevant for your order, you need to look at the other side of the transaction. This means if you wish to buy, you will need to look at the sellers’ asking price to determine what you could buy them for, and vice versa if you are wishing to sell.

04

Order queueing

The stock exchange works on a first-come-first-served basis and uses a queuing system for those investors that have placed limit price orders – one queue for buyers and one queue for sellers.

  • Buyers – at the top of the queue, are those investors willing to pay the most to buy the shares (this is the quoted buy price). The queue then descends in price order, down to those who are willing to pay the least.
  • Sellers – at the top of the queue, are investors willing to receive the least for their shares (this is the quoted sell price) down to those who are seeking the highest price to sell their shares.

Remember:

If multiple investors place an order at the same limit price, these will be queued in the order that they were placed on the market. For example, if you wish to buy a particular stock at $1.15 and two other people already have buy orders on the market for $1.15, they are ahead in the queue and their orders will be filled before yours.

05

Market depth

It can be useful to look at the depth of the market when placing orders to see the other orders currently on the market. Market depth allows you to see where your order might trade or go into the queue, depending on the price and quantity you set.

Market depth shows:

  • the supply and demand for stock at various prices
  • lists the buyers and sellers who have an order on the market at a particular price
  • how many shares (volume) are up for sale (asks)
  • how many shares are requested by buyers (bids)

For example:

  • If you wanted to buy 2,000 shares and didn’t want to pay more than a limit price of $3.15, your order would be placed in the queue behind the two other buyers with a limit price of $3.15. All three buyers would be queued until a seller or sellers were willing to accept $3.15 to sell their shares. You would need to wait for their orders for a total of 7,765 shares to be traded before you could buy shares at that price.
  • If you wanted to buy 2,000 shares at market price, you would pay $3.155 for all 2,000 shares and your order would trade straight away.
  • If you wanted to buy 7,000 shares at market price, you would pay $3.155 for 2,128 shares (all of the share the top sellers have) and $3.16 for the remaining 4,872 shares, as you would need to buy these from the next sellers in the queue. Your order would trade straight away.

06

Market anomalies: pre-open and pre-close

Trading normally takes place at any time during market trading hours, however some experienced investors take advantage of the two small windows of opportunity before and after the market officially opens and closes. These are called pre-open and pre-close periods, during which time investors that really want to trade on market opening or market closing can place a limit price.

No trading actually takes place during these periods. Orders are placed and are visible on the market, but are not matched and executed during this time; the orders are held in the system for evaluation by the stock exchange, using a special algorithm to determine a price that matches both buyers and sellers (called a ‘match-off’ price). The match-off price is the price the share will trade at when the market opens. Find out more details about match-off transactions.

Trading hours

Find out about the trading hours for the markets you can trade through ASB Securities.

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ASB Securities Limited is a NZX Firm. ASB Securities terms and conditions apply. The above information is a guide only and should not be relied on as it does not take into account your personal financial situation.

ASB Securities Understanding how the share market works