- Understand the basic roles: exchanges list stocks, brokers connect you, and market makers provide liquidity.
- Stock prices are set by supply and demand, buyers and sellers matching orders determine the last traded price.
- Common order types (market, limit, stop) affect execution speed and price control, use them deliberately.
- Order routing, liquidity, and bid-ask spreads influence transaction costs even with zero commissions.
- Practical examples ($AAPL, $TSLA, $AMZN) show how price discovery and order types work in real trades.
- Avoid common mistakes: trading on emotion, ignoring order types, and underestimating fees and taxes.
Introduction
The stock market is the network where buyers and sellers trade shares of companies. At its core, it matches orders so ownership of shares can change hands.
This matters for investors because how the market works affects the price you pay, the price you receive, and the risks you run when trading. Knowing the mechanics helps you make better choices and control costs.
In this guide you will learn the market structure (exchanges, brokers, market makers), the common order types, how supply and demand set prices with simple analogies, and practical tips to place trades. Real-world examples using recognizable tickers will make abstract ideas concrete.
1. Market Structure: Who Does What
The market is not a single place but a system with different participants. The main players are exchanges, brokers, and liquidity providers (market makers). Each has a clear role.
Exchanges
Exchanges like the New York Stock Exchange and Nasdaq are regulated venues where listed stocks are available to trade. They publish rules for listing, trading hours, and reporting trades.
Many stocks trade on more than one venue or in alternative trading systems (dark pools). The exchange records the official trades and often hosts order books you can view through broker platforms.
Brokers
Brokers are the gateway between you and the market. Retail brokers accept your orders, perform compliance checks, and route orders to an exchange, market maker, or internal matching engine.
Different brokers use different routing practices. Some prioritize speed, others payment-for-order-flow arrangements. Choosing a broker affects execution quality and available tools.
Market Makers and Liquidity Providers
Market makers continuously post buy (bid) and sell (ask) prices for stocks to help trades execute without waiting for a matching counterparty. They earn small profits on the spread between bid and ask.
Without liquidity providers, large orders could move prices dramatically. Liquidity helps smooth price discovery and reduces the chance that a trade fails to execute.
2. Orders: How You Tell the Market What to Do
An order is an instruction from you through your broker describing whether to buy or sell, how many shares, and under what conditions. Choosing the right order type balances speed, certainty, and price control.
Market Orders
A market order buys or sells immediately at the best available price. It prioritizes execution over price. Use market orders when speed matters and the stock is liquid.
Example: If you place a market buy for $AAPL with a visible best ask of $150.10, your order will likely fill near that price. In fast-moving or thin markets, the actual fill can be higher or lower.
Limit Orders
A limit order sets the maximum price you're willing to pay (buy) or the minimum you will accept (sell). It prioritizes price over immediacy and may not fill if the market doesn't trade through your limit.
Example: A limit buy at $TSLA $650 will only execute at $650 or better. If the stock never drops to $650, your order remains unfilled.
Stop Orders and Stop-Limit
A stop order becomes a market order when a trigger price is reached, commonly used to limit losses. A stop-limit becomes a limit order at the trigger and protects against extreme fills but can fail to execute.
Example: If $AMZN trades at $110 and you place a stop-sell at $100 to limit downside, once $100 is hit your order becomes a market sell and will execute at the next available price.
Other Instructions
Time-in-force (day, GTC, good till canceled), all-or-none, and fill-or-kill are instructions that control how long and under what conditions an order may execute. Use them thoughtfully for advanced control.
3. Price Discovery: How Supply and Demand Set Prices
Price discovery is the process by which market prices emerge from the interaction of supply (sellers) and demand (buyers). The last traded price is the most recent point where the two sides agreed on a quantity and price.
Simple Analogy: The Farmers' Market
Imagine a farmers' market where sellers display apples and buyers shout the prices they’ll pay. Sellers lower prices if no one buys; buyers raise offers if there’s high demand. The transaction price is where a buyer and seller agree, this mirrors stock trading.
Large orders are like someone wanting a truckload of apples: sellers may raise prices or spread sales across many stalls, affecting the market price more than a small purchase would.
Bid-Ask Spread and Market Depth
The bid is the highest price buyers are willing to pay; the ask is the lowest price sellers will accept. The difference is the bid-ask spread, a key cost of trading that widens in volatile or illiquid stocks.
Market depth shows additional bids and asks at prices beyond the best quote. Thin depth means even moderate orders can move the price substantially; deep depth absorbs larger orders with less price movement.
4. Execution and Settlement: What Happens After a Trade
Execution is when your order matches and a trade occurs. Settlement is the exchange of cash and shares that follows. Understanding both helps with timing and record-keeping.
Trade Execution
When your order matches, the exchange reports the trade and updates the price. Your brokerage account will reflect a pending trade until settlement completes. The fill price is what matters for calculating gains and losses.
Partial fills can occur when only part of your order is matched immediately. Large orders are often filled in pieces across different prices.
Settlement
Settlement is the legal transfer of the security and payment. In U.S. equities, settlement typically occurs two business days after the trade date (T+2). Until settlement, certain actions, like using proceeds to buy another stock, are restricted by margin or settlement rules.
Keep settlement timing in mind for tax reporting and for intraday strategies that rely on immediate access to funds or shares.
Real-World Examples: Putting It All Together
Example 1, Buying a Liquid Stock
You place a market buy for 100 shares of $AAPL. The quote shows bid $150.00 and ask $150.05. Your market order likely fills at $150.05 or slightly higher. The cost is roughly 100 × $150.05 = $15,005 plus any small fees. Because $AAPL is liquid, the spread is tiny and execution risk is low.
Example 2, Selling a Thinly Traded Stock
You want to sell 1,000 shares of a smaller company. The best bid is $5.00 but bids drop sharply below that. A market sell could execute many shares at much lower prices, driving down the price. Using limit orders and working the order in smaller pieces can reduce price impact.
Example 3, Using a Stop Order
You bought $TSLA at $700 and place a stop-sell at $650 to limit loss. If news triggers a fast decline, the stop becomes a market sell and may fill at $640 or lower. If you want a floor, consider a stop-limit (with the trade-off that it might not execute).
Common Mistakes to Avoid
- Trading on Emotion: Reacting to headlines causes poor timing. Have a plan and stick to rules for entry, exit, and position size.
- Ignoring Order Types: Using market orders for illiquid stocks can lead to bad fills. Choose limit or staged orders when price control matters.
- Underestimating Costs: Even with $0 commissions, spreads, slippage, and fees matter. Track total costs including the bid-ask spread.
- Not Understanding Settlement: Assuming funds are immediately available can lead to rejected trades or violates regulations. Remember T+2 settlement in US markets.
- Overlooking Broker Routing: Different brokers route orders differently. If execution quality is critical, research your broker’s practices and execution reports.
FAQ
Q: How is the “price” I see on my screen determined?
A: The displayed price is the last executed trade. Real-time quotes show the current best bid and ask. Prices change as orders match or as new bids/asks enter the market.
Q: What’s the difference between slippage and the bid-ask spread?
A: The bid-ask spread is the visible difference between buyer and seller quotes. Slippage is the difference between the expected fill price and the actual executed price, often caused by fast moves or insufficient liquidity.
Q: Do I need a broker or can I trade directly on an exchange?
A: Retail investors need a broker to access exchanges. Brokers handle compliance, order routing, and reporting. Institutional participants can have direct access but face higher entry requirements.
Q: Are orders always public on the exchange?
A: No. Some orders are visible in the public order book, while others go to dark pools or are internalized by brokers. Visible depth is useful, but not all liquidity is shown publicly.
Bottom Line
The stock market matches buyers and sellers through a system of exchanges, brokers, and liquidity providers. Prices emerge from supply and demand; the last traded price represents the most recent agreement between a buyer and seller.
Learning order types, understanding bid-ask spreads and liquidity, and choosing a broker with good execution are practical steps that improve trading outcomes and reduce surprises. Use market orders when speed matters and limit orders when price control matters.
Next steps: open a practice or paper trading account to experiment with order types, review your broker’s execution policies, and track real trades to measure spreads, slippage, and costs. Continued practice will make the market mechanics familiar and help you trade more confidently.
