For the shares of any joint stock company the exchange rate is determined separately. Broker – a specialist is authorized to determine the prices of shares. Brokers – specialists is a separate group of traders in the stock market with a special status. Brokers – specialists are responsible for liquidity of stocks’ trading. Broker – specialist deals with shares of one company or a group of companies. Brokers perform the task of ensuring liquidity of shares’ turnover by, among the other ways, determining the price of shares at the session.
As mentioned, each broker-specialist deals with the fixing of the price of one type of share (eg. Microsoft). Other brokers communicate to him their orders for the purchase or sale of those very shares whose the price is determined. After collecting orders from brokers, broker-specialist prepares, so called, order book. There he writes all purchase-sell orders, offered prices and number of shares offered. In this manner grouping occurs, confrontation of purchase-sell orders of the shares and by comparing supply and demand broker-specialist sets unitary price of shares in the trading session.
The basic rule is the rule for determining the maximum rate of exchange trading. It means that the exchange rate is set at a level at which most transactions take place.
It should be remembered that the order to buy or sell of the APD type (At the Price of the Day) must be completed. Customer – the client giving this formula of price in his order (unlimited order), is sure that he will buy or sell shares at the session. He just doesn’t know at what price. He already, in advance agreed on the price, which will be determined in the course of the trading session. After fixing of exchange rate, the execution of orders takes place according to the following scenario:
Rules for the sale/purchase transactions
As mentioned earlier, the order of APD type have to be completed. The purchase orders with the specified limit price (limited order) higher than the exchange rate have to be completed. The sale orders with the specified limit price lower than the exchange rate need to be realized as well.
Purchase orders with a limit price equal to the session price can be partially executed, if there was a difference between demand and supply or completely, if the offers are balanced, or if the broker-specialist decides to intervene.
Purchase orders with a limit price lower than the exchange rate have to be rejected. The sell orders with limit higher than the exchange rate have to be rejected as well.
You can acquaint the method of determining the exchange rate thanks to simulated order book. Analysis of the sheet will help to familiarize yourself with the procedure of determining the exchange rate.
1) – price $ 160
– Supply of 240 shares
– Demand for 710 shares
Sizes possible to transact: 240 shares. No more shares at this price. For the rest of the selling the price is too low. Therefore only 240 shares can change the owner. Will it be, this way, at such a price, the rule of maximum rotation, satisfied? Further review of prices and offers will provide the answer to this question.
2) – price $ 170
– Supply of 400 shares
– Demand for 600 shares
Possible Transaction: 400 shares.
3) – price $ 180 (exchange rate)
– Supply of 500 shares
– Demand for 510 shares
The transaction will include 500 shares. At this price the largest number of shares changes hands. Size of exchange transaction with these shares will be greatest. Thus, the basic rule for determining the exchange rate, will be satisfied.
To be sure, it is worthwhile analyzing other items:
4) – price $ 190
– Supply of 580 shares
– Demand for 400 shares
Possible Transaction: 400 shares.
5) – price $ 200
– Supply of 660 shares
– Demand for 230 shares
Possible Transaction: 230 shares. At that price, although 660 shares can be sold, but desire is only expressed for purchase of 230 shares. For other buyers the price is too high.
Description of rules for the sale with fixed exchange rate of $180:
Principle 1 .: buyer has no price limit, described it as APD, so he’s ready to enter into a transaction. Seller according to the APD order acted the same way as above. APD orders are executed.
Principle 2 .: purchase orders numbered 1, 2, 3, where the limit of the purchase price was set above the exchange rate, are completed.
Principle 3 .: sale orders numbered 1, 2, 3, where the limit of the selling price is set below the exchange rate, are completed.
Principle 4 .: orders for buying and selling numbered 4 and 4 with limited purchase-sell price equal to the exchange rate are completed partly.
When you remember about the priority of orders according to the rules 1, 2 and 3, it turns out that the order with limited price equal to $180, although reached the exchange rate, won’t be fully realized. There are 10 shares missing to balance the session. This fact can be seen in both the cumulative number of 500 shares and 510 shares, as well as for orders with a limit of $180: 100 and 110 shares. A client from 110 shares ordered, can buy only 100. He won’t buy the missing 10 because they are not offered on the stock market that day at the right price.
Broker-specialist (responsible for the trading liquidity of the particular share, with the exchange rate he has established already) may:
– Balance the trading session by selling the client these missing 10 shares from his own stakes. In order to enable such interventions balancing the stock market, a broker-specialist has a separate fund at his disposal.
– Give up intervention. Customer’s order is partially executed. Instead of buying 110 shares, he buys 100.
Principle 5 .: purchase orders number 5 and 6 with a limit price lower than the exchange rate shall be rejected.
Principle 6 .: sales orders number 5, 6 and 7 with a limited price higher than the exchange rate shall be rejected.
Price – $180: all transactions put into execution will be carried out at that price.
For merchants who reported higher prices, as well as for retailers who reported lower prices, it will be somewhat pleasant surprise. That’s how fixed price is determined and the sale and purchase of shares in the trading session are carried out.
There are some regulations (which may be modified depending on the needs of the market), which also determine the exchange rate and affect the regulation of the liquidity of shares’ trading. There are, for example: certain trade restrictions if the disparities of supply – demand are too large. In addition, to prevent large changes in share prices on the stock market, which can be dangerous for the market and for those customers who have used the APD formula, the principle was introduced that permitted change of exchange rate from one session to another, being within the limits of the (tunnel) ± 10% level of the previous rate. (This guarantees the APD formula, because the client commissioning the APD operation knows that he will not sell cheaper nor buy pricier as + 10% of the previous rate). In the above example it would look like this: trading session rate $180, and a possible rate of next session is ± 10% of the previous exchange rate, ie. 162-198 $ per share.
I mentioned above about some restrictions of trade in the stock exchange when there is imbalance of supply and demand. For such a glaring disparity is considered a spread at which you can’t shape the exchange rate according to the principle of ± 10%. Then the stock exchange notes the rate equal to the permissible lower or upper (by ± 10%).
In such a situation, if after setting a new rate of the demand offers and supply offers are relative to each other with disparities of less than 1: 5, then there is a reduction of orders on the side of the majority. This can be a RP type of reduction (reduction of purchase) or RS (reduction of sales). Statement from the stock market informs about such facts.
It’s different, when after establishing a new rate, disproportion of purchase and sale, relative to each other is greater than 1:5. Then the transactions are not concluded.
Further reading: http://nse-india.com/content/press/feb2003c.pdf