Post No: 31
Date: 14.05.2016
Topic: How we used to
trade and how are we trading now?
The
Technology has brought many facilities to the human mankind. In the earlier
days the buying and selling of goods was used by barter system. Later on, the
civilized society brought into the mechanism called “currency”. But still there were many difficulties to
buying and selling of goods.
What is a market?
It
is a place where both buyers and sellers meet. But when a buyer wants to buy a
particular goods or any article, the buyer needs to know the price offered by
all the sellers. The buyer will have to look into the prices, so that he gets a
best price in the market. Generally in the financial markets terminology, the
buyer at which he is willing to buy is known as “bid” price. As a buyer, it is
obvious that we will look into the lowest price in the market. On the same
lines, the seller who wants to sell something will look for a better price to
sell or the highest price for his goods.
Therefore, a buyer will look for a lowest price and a seller will look
for a highest price. The selling price at which the seller is willing to sell
is known as “offer” price in the financial markets.
What were the methods to buy and sell in
olden days?
In the olden days, there used to be an “open outcry system”. This open outcry system can be seen even in today’s world, when we go out for buying vegetables in some parts of the world. The open outcry system for financial markets also resembles the same vegetable markets, but with certain modifications. To understand, how an open outcry system appears, we can look into the following diagram:
I
have tried my best to draw a diagram, instead of copying and pasting from
somewhere else. All the sellers will be standing in the well (not really a well
of water) typed system. All the buyers will be watching those sellers around
the pool / well. The buyers and sellers will be using “hand signals” / “special
sign signals” or verbal ‘bid’ and ‘offer’ prices. One of the major
disadvantages was the information in one market would not flow to other nearby
markets.
What is the present
way of buying and selling?
For
the financial markets, now with the rapid and innovation of technology, for
buying and selling of financial instruments, there are many exchanges. These
exchanges enable both the buyers and sellers meet and give their quotes through
electronic means. They provide us a platform, where we can view the various bid
(buying) prices and also the offer prices (selling). These exchanges use “electronic
algorithms” to enable trading (buying / selling) mechanism.
What are the risks in trading with exchange
and without exchange?
|
Type of risks
|
In one to one or
without exchange
|
Trading by using
Exchange
|
|
Contract execution
|
No guarantee that
the contract to buy or sell will be executed
|
It can be avoided
|
|
Price risk
|
There is no
guarantee that we can buy at the agreed price (if we are buying in future
through a forward contract)
|
It can be avoided
|
|
Legal risk
|
If we are having a
positive MTM, the counterparty may can cancel the contract or may not honor
the contract
|
It can be avoided
|
|
Operational risk
|
The counterparty may
cancel the contract or may not stick to the prices or procedures or failure
to honor the contract
|
It can be avoided
|
|
Similarly, the
parties may not have trust on each other, it would invite many other risks
like settlement risk, liquidity risk etc from both parties (buyer and seller)
|
||
For any doubts, contact at my personal mail id: cfa.surya@gmail.com
