What is the mechanism for trading shares

[bogdanel]

Hello everyone,

I have had a question for a long time. I don't really understand the forex,cfd's, shares mechanism. It is a bit paradoxal. I am not a novice trader but I don't understand this elementary thing.

In fact we are betting on the shares/cfd's/currency rate. If our bet is winning we receive money. My question is : From where do we receive this money?
For example : If we trade cfds ( cfds are kind of contracts with the broker right ?) from where woud the broker take money to give it us ?

It is the same thing for shares. We trade the share price right ? So where does our income come from ?

I hope I was enough clear, If not don't hesitate to ask me to explain more. I know that my english is not the best one

Thank you

 

[timsk]

. . .I hope I was enough clear, If not don't hesitate to ask me to explain more. I know that my english is not the best one.

Hi bogdanel,
Welcome to T2W.

Your English is fine - no worries on that front. The precise mechanism varies from one financial vehicle to the next. The term ‘financial vehicle’ refers to the specific product you use to trade, as opposed to your choice of market or instrument within that market. So, for example, if you want to trade Google - which is just one of thousands of ‘instruments’ in the stock market, there are lots of financial vehicles for you to choose from. The most common ones are: shares, spread betting, contracts for difference (CFDs), (single stock) futures, options, binaries and warrants. That’s no less than seven different financial vehicles to trade just one instrument!

To answer your question, in broad terms, if you're buying an instrument - e.g. Google in the example above - you're buying from someone who wants to sell. The price is agreed and the trade is made. So, if you own Google shares and the price rises and you want to turn your paper profit into hard cash, you have to find someone else to sell your shares to. When a buyer is found, you're then able to pocket the difference between the lower price you bought the shares for and the higher price you sold them for.

I hope that answers your question.
Tim.

 

[bogdanel]

Hello timsk,

I understand what you say and I understand better now the " financial vehicle " but my incomprehension is not there. In the example you gived with Google, we must own shares before to sell them. It is very logical. First you buy and then you sell. But sometimes you can directly sell even though you don't own things.
For example : When you trade raw materials or stock indexes you can directly sell. In this case, we don't sell or buy something, we " bet " on the price of Gold, petrol, ...

We can take profit by selling or buying. If the price ( of gold for example ) goes down and we have sold before, we win.
In this case you don't buy something at low price and sell when the price grows up.

Thank you for your time

 

[timsk]

. . .We can take profit by selling or buying. If the price ( of gold for example ) goes down and we have sold before, we win.
In this case you don't buy something at low price and sell when the price grows up.

Hi bogdanel,
If I've understood you correctly, I think you're asking how it's possible to profit when an instrument falls in value - as opposed to rises in value? The practice is known as 'short selling', which I'll explain sticking with Google as an example. For the sake of argument, let's say Google is currently trading at $850 per share - but you expect the price to drop. You want to trade 100 shares which, for a small fee, your broker will lend to you. You find a buyer for the shares who pays you $85,000 but, remember, this is not your money as you didn't own the shares in the first place. Now, let's assume the price falls to $800 per share, at which point you buy the shares back (known as 'short covering'), costing you $80,000. You return the borrowed shares to your broker - along with their fee - and pocket the difference of $5,000.

It's important to remember that had the value of the shares risen instead of fallen - say to $90,000 - then you would have lost $5,000! So, with most trades, you are speculating about the direction an instrument will move - either up or down. In very basic terms, get the direction right - you'll make a profit, but if you get it wrong - you'll make a loss.
Tim.

 

[bogdanel]

Hi timsk,

So, when we sell something that we don't own, the broker does some manipulations so that we may sell. And I suppose that the same principle is applied to raw materials ? If we sell oil ( we expect the price to drop ) , the broker will lend us a certain number of barrels, right ?

What happens if I want to sell when a barrel costs $140 and if the broker has not enough barrels to lend me ?
It is a bit strange this story of lending because if the broker lends us too much and we lose our trade, the broker will also be in loss.

Sorry to bother you with so many question, but now the answer is much more clear :clap:

 

[timsk]

. . .Sorry to bother you with so many question, but now the answer is much more clear :clap:

Hi bogdanel,
In my first reply I said that "The precise mechanism varies from one financial vehicle to the next." You can't buy and sell shares in order to trade barrels of oil, so you have to use a different financial vehicle. Typically, this is 'Futures' - which operates slightly differently to the way shares work. It's simply not practicable for me to compare and contrast how all the different financial vehicles work - so you're going to have to do read up the Stickies and FAQs for that. The bottom line is that regardless of the market you trade (e.g. shares like Google or commodities like oil) - there are mechanisms in place to enable you to 'sell short' - as explained in my last post - and profit from a drop in value.
Tim.

 

[bogdanel]

Thank you very much

Daniel