The Journey of a Trade

Key  Ideas

  • All securities are involved in the same process connecting the buyer and seller
  • The journey of a trade involves execution, settlement, and clearing of any security traded

Setting the scene

Larry, an Apple bond, is looking to be traded on the market. As a bond, Larry goes through an entire journey before becoming part of an individual's investment portfolio. The journey starts when someone (could be you!) decides to buy Larry. The trader submits an order to a broker, who then forwards it to an exchange. Larry could be traded on the NASDAQ, the New York Stock Exchange (NYSE), or over-the-counter (OTC), depending on where he is listed. Once Larry is on the exchange, he joins a queue with other trades waiting to be executed. 

Larry waits patiently in the queue until he is matched with a counterparty who is willing to sell him at the same price the trader is willing to buy him. Once the trade is executed, Larry's settlement process begins. This involves the transfer of ownership and cash between the buyer and seller. The clearing process ensures that the trade is valid, and all parties meet their financial obligations. This process can take a few days, but it ensures that the trade is settled accurately and efficiently.

Even though Larry the Apple bond is a relatively low-risk investment, he is subject to the same process as all other trades. This is to ensure that all parties are protected. After this process is complete, Larry becomes part of the buyer’s investment portfolio, generating income and contributing to the goodwill of the market.

The Role of Brokerages

Since financial markets are robust and can be engaged by many parties, there is a plethora of buyers who can execute trades. At large, these buyers are split into retail and institutional buyers. Retail traders buy and sell securities for personal investment, while institutional buyers manage large amounts of money on behalf of their clients.

Institutional buyers can execute orders through a variety of channels, including direct access to the market, electronic trading platforms, and over-the-counter (OTC) markets. Institutions have access to better pricing and execution through the use of complex algorithmic trading that focuses on finding orders within the best bid-ask spreads.

While institutions can access the market in other ways, both retail traders and institutions can leverage the use of brokerages. Institutions are known to use brokerages to execute orders in markets will limited access or for complex trades that fall out of their wheelhouse. Retail traders can execute orders through a brokerage, which acts as an intermediary between the trader and the market. Brokerages provide traders with access to various markets and financial products, allowing them to execute trades quickly and efficiently. 

Here’s where it gets confusing. Just like institutions use brokerages, brokerages can use institutions. Take Robinhood, for example, a firm that leverages Citadel to attain the most optimal prices for its customers. While brokerages and institutions have somewhat of an interdependent relationship, the vast majority of retail traders use some form of brokerage to manage their portfolios.

The Clearing and Settling Process

When you execute a trade, the DTCC helps to settle the trade. This means that it ensures that the securities (like bonds) you bought or sold are delivered to the right people and that the money for the trade is transferred correctly. The DTCC works behind the scenes to make sure everything is done accurately and securely.

For example, if you sold some Apple bonds, the DTCC would make sure that the buyer gets the bonds they paid for and that you receive the money from the sale. This can take a few days, typically 2-3 business days for most bond trades, but it can vary depending on the type of bond and how the trade is settled. Overall, the DTCC plays a very important role in ensuring that trades are settled correctly and efficiently, which helps to keep the financial markets running smoothly.