What is Electronic Trading? (complete guide)

About Electronic trading (e trading)

Electronic trading involves the online buying and selling of various financial instruments such as shares, bonds, foreign currencies, and cryptocurrencies. The traditional methods of auction markets and phone trading are gradually giving way to electronic trading systems, marking a shift that has democratized securities trading and brought about significant transformations. While some exchanges, like the New York Stock Exchange (NYSE), still utilize the auction system with specialists physically present, electronic trading platforms and exclusively electronic exchanges are swiftly emerging, claiming heightened efficiency.

The advantages of electronic trading include swift transaction speeds, cost savings, effective risk management, and the facilitation of well-informed decision-making. Furthermore, it has expanded access to the securities market globally, enabling millions of individuals to trade billions of shares across diverse platforms.

An appealing aspect is that one doesn't need to be an expert, as various fintech solutions such as robo-advisors, algorithms, and smart order routers handle the intricacies. However, this convenience should not be underestimated, as there are pitfalls to navigate. The human element remains crucial, and the more one learns about the market and its underlying logic, the greater the chances of success. Let's delve into the mechanics of how this intricate system operates.

Understanding the Basics

Before delving into the intricacies of electronic trading, let's revisit the fundamentals of securities trading.

For companies to fund their operations, they opt to sell shares of their enterprises to investors, transforming them into shareholders. These shareholders possess fractional ownership of the company and hold limited rights to a share of its assets and earnings. The value of shares is subject to fluctuations influenced by economic conditions, the company's performance, and investor sentiments. To facilitate the trading of shares and various financial instruments, participants engage in transactions either through stock exchanges or over-the-counter platforms. Brokers, individuals licensed to trade securities through these exchanges, act as intermediaries in these transactions. In the realm of electronic trading, the responsibility falls on online brokers to facilitate and execute these transactions.

Where and What Can You Trade?

Financial securities find their market either on an exchange or through over-the-counter (OTC) transactions. An exchange represents a centralized and regulated marketplace where securities are listed and traded in a standardized and publicly transparent fashion. Typically, prominent companies opt for exchanges to conduct their securities transactions. However, certain entities may choose not to or are unable to list their financial products on exchanges. In such cases, they engage in over-the-counter trading facilitated by decentralized dealer networks, often referred to as electronic communication networks (ECN). These networks are entirely computerized, operating with a level of regulatory flexibility compared to exchanges.

Various financial instruments are available across different platforms, each catering to specific needs. Some platforms specialize in equities trading, while others focus on different types of derivatives (options, forwards, futures), and foreign currencies. Banks often serve as market makers for bonds, offering them through broker-dealer networks. In the past decade, with the rapid advancement of technology, cryptocurrencies have gained popularity. Dedicated platforms have emerged for trading crypto pairs, effectively meeting the electronic trading requirements of both buy-side and sell-side clients.

Which Electronic Trading Strategy Should You Choose?

As electronic trading platforms gain prominence, a multitude of trading strategies emerge, each tailored to the preferences of individual traders. It's crucial to select a strategy aligning with your lifestyle, personality, and the resources you have at your disposal. The choice also hinges on the specific financial instruments you intend to trade, as strategies differ between, for instance, foreign exchange and equities trading.

Various popular trading strategies cater to different trading intents. Among them are the news trading strategy, day trading, scalping, and arbitrage. The effectiveness of a strategy often relies on its alignment with your personal circumstances and the type of financial assets you are engaging with.

How to Begin Electronic Trading?

Simplifying the process, initiating electronic trading involves several key steps:

1. Select an Online Broker: To enter the stock market and commence buying and selling, you must first open a brokerage account with a broker-dealer. These firms act as gateways to the stock market, offering different services at varying prices. Consider the following when choosing a broker:

The amount you plan to invest.

The frequency of your trades.

Your trading experience.

The financial instruments you intend to trade, such as stocks, options, futures, bonds, foreign exchange, or cryptocurrencies.

2. Open a Brokerage Account: Regardless of your chosen broker, common tasks include:

Verifying if you meet account entry criteria (age, minimum investment, etc.).

Providing access to trading platforms.

Maintaining a record of owned stocks.

Monitoring your trading activities.

Offering real-time stock quotes.

3. Execute Trades: Once your account is set up, monitor stock quotes to track price changes. Based on market conditions, decide whether to buy or sell shares. Here's what happens next:

When you place a buy order, your broker-dealer sends it to the exchange where the company's stocks you want to buy are traded.

The exchange attempts to match your buy order with a sell order from another party.

If a match occurs, your trade is executed. If not, your order remains at the exchange until a match is found.

After the trade, your broker-dealer is notified, and your account is updated – funds are deducted, and new stocks are added to your portfolio.

4. Ownership Records: Alongside your broker-dealer, a central repository (such as the Depository Trust Company in the USA) holds information about stock ownership across the market. This entity is informed of your trade and manages the transfer of ownership from the seller to the buyer.

By following these steps, you can navigate the process of electronic trading and engage in buying and selling financial instruments efficiently.