[MUSIC] In this video we will start looking at the mechanics of trading. Specifically we will define what orders are and look at the two most common types of orders, market orders and limit orders. We will also list the main pros and cons of these two types of orders and define what limit prices are. Until now we have focused on the basics of financial statements and ratio analysis and also the relationship between systematic risk and expected returns. We now move on to our next topic, which is understanding the mechanics of trading on exchanges, as well as measuring associated trading costs. The mechanics of clearing will list the common types of orders you can use while trading, and illustrate how orders get executed on exchanges. Transaction costs eat into returns that you earn from your investments, so it is important to understand how to measure transaction costs and then use and manage your orders in such a way to minimize your transaction costs. The first step in understanding the trading process Is to define what orders are. When you want to trade a financial security on an exchange, you have to send instructions to the exchange, typically to your broker. These instructions are called orders, an order must always specify the security or securities you want to trade, specify whether you want to buy or sell them, and the quantity you want to trade. The securities usually specify using a ticker symbol. For example, the ticker symbol for Amazon is AMZN, and that of Ford Motor Company is F. Your order may also include some other instructions, like what price you're willing to trade at when the order expires, if the order must be executed completely, which exchange the order must be sent to, etc. The simplest type of an order is called a market order. It includes only the three required instructions. That is the security you want to trade, whether you want to buy or sell, and the number of shares you want to trade. For example, an order to buy 100 shares in Twitter is a market order. This order accepts whatever price is currently available in the market. There is almost no uncertainty in execution, but the price at which you buy these 100 shares is uncertain. At times, this uncertainty in price may not be a good strategy. For example, you may not be willing to pay more than $19 a share for 200 shares as you feel that at a greater price there are no profits to made from buying shares at. To avoid trading at a price that is unacceptable to you in addition to the three instructions, you may also specify the price at which you're willing to trade. Such orders are called limit orders. They still include the basic three instructions, but also include a price as a [INAUDIBLE]. They still include the three basic instructions, but also include a price as a fourth instruction. Since you're not willing to buy Twitter shares at above $19, your limit order would be to buy 100 shares of Twitter at the price of $19. This price is refered to as the limit price. For a buy order, the limit price ensures that you do not buy at a price greater than $19. The maximum price at which you could trade is $19. Prices lower than $19 are however acceptable. Similarly for sale orders, the limit price is the least price that which you are willing to sell. Similarly for sale orders, the limit price is the least price that which you are willing to sell. Say you set a limit order to sell 50 shares of Twitter with a limit price of $20. This ensures that you never sell the 50 shares at less than $20 a share but any price equal to or greater than $20 is acceptable. With limit orders you will not trade at unfavorable prices but then its execution is uncertain. To summarize, with market orders, execution is certain but price is uncertain. While, with limit orders, execution is uncertain, but price is, more or less, certain. Your order choice will depend on whether you want quick execution or you want to control what prices you trade at. Most exchanges these days are what are called electronic limit order markets. On these markets, limit that market orders and then trade with each other. Next time we will see how limit and market orders form the order book and interact with each other. [MUSIC]
