Equities trading is the buying and selling of company shares. There are a few ways you can trade equities, let’s take a look at each below.
What is equity trading?
Equity trading is the act of buying and selling company shares, investment funds or exchange-traded funds (ETFs).
It’s also commonly known as share trading, share dealing or investing. But in recent years, equity trading has also become synonymous with the more speculative side of financial markets, which involves equity derivatives trading – which we’ll go into more later.
Often, financial markets are divided into two classes, one being equities and the other FICC, which stands for fixed income, currencies and commodities.
What are equity markets?
Equity markets are any marketplace in which company shares can be issued and traded. There are two types of equity markets: exchange-based and over the counter (OTC).
Equity exchanges, more commonly known as stock exchanges, are found all over the world. Famous examples include the New York Stock Exchange (NYSE) and London Stock Exchange (LSE).
Companies start as private, meaning ownership is only held by a few individuals – often the founders, employees and venture capitalists.
Then, some firms – but not all – will decide to ‘go public’ to grow their business by raising capital and boosting brand awareness. To do this, they need to issue shares. The most common means of doing so is to list on exchanges through an initial public offering (IPO), SPAC deal or direct listing.
The company gives up a certain percentage of its ownership in exchange for capital from institutions and investors, in what’s known as the primary market. Once the shares are listed, trading on the secondary market begins, which is where stock is sold from one investor to another.
Exchange-traded equities are highly regulated. There’s a public order book that records every transaction made, and the levels of trading volume each day. Plus, to even list companies must meet certain liquidity levels, and commit to reporting requirements, such as annual reports and interim earnings guidance.
OTC equities, on the other hand, are usually privately traded stocks or companies that don’t meet the regulatory requirements of exchanges. OTC shares trade through dealers or directly between two investors.
OTC markets are far less regulated, as there’s no public record of any transactions, and have significantly lower liquidity.
How does equities trading work?
Equities trading works by matching up the demand for and supply of a company’s stock in an open marketplace. In the equity market, you’ll see two prices listed:
- Bid price – the price a buyer offers to a seller
- Ask price – the price a seller wants from a buyer
When these prices align, a sale occurs. But as there are so many participants looking to buy and sell the same shares, prices will fluctuate depending on the best price at the time.
When there is a lot of demand for a stock – usually as a result of positive news or good earnings – the price usually rises as sellers can request more for the stock.
But if a company is not doing well, demand for its stock falls and sellers may struggle to find anyone willing to buy their holdings. To make a sale, they’ll have to lower their prices.
How to trade equities
There are a couple of different ways you can trade equities: investing directly in the company’s shares or through derivative products.
What is cash equities trading?
Investing in equities is often known as cash equities trading, as it involves buying and selling the shares and ETFs directly (or in cash). To do so, you’d need to use a broker to execute transactions on your behalf, as most exchanges don’t allow individuals access to an order book.
You take ownership of the shares you buy and hold them in the hopes the price rises and you can sell them later for a profit.
As a shareholder, you might get certain rights, such as the ability to vote on decisions and dividends if a company issues them.
What is equity derivatives trading?
Equity derivatives trading is the use of derivative instruments to trade on the underlying price of a company.
Derivatives are used as speculative assets, as you won’t need to own the asset to trade it. So, if you wanted to open a short position where the stock will fall in value, you wouldn’t need the shares to sell.
There are a few different derivatives that you can use to trade shares. Popular examples include:
- Options – these contracts give the holder the right, but not the obligation, to buy or sell a company’s stock at a certain price on a set date of expiry
- CFDs – these are an agreement to exchange the difference in a company’s share price between when a position is opened and when it is closed
Most derivatives are leveraged, which means that you only need a deposit – known as margin – to open a position with full market exposure. However, profits and losses are based on the total value of the trade, not just the margin. So, it’s possible that your profits and losses can be magnified, making it important to manage your risk appropriately.