How to trade shares

To trade shares, you must have an account with a stock broking company or an ASX licensed intermediary (financial planner or accountant etc) - this is to ensure the trading environment is secure and to ensure you understand the risks involved. Many new investors have brokers to begin with but some prefer to do their own research and use online brokers such as Comsec and E*Trade.

Most brokers require you to provide funds in a cash management account – ensuring you have the funds to process new buy orders. Online brokers require you to have an account with their associated financial institution before you can begin trading. Commsec does not require the funds in your account before the trade is entered into, however E*Trade requires funds in an investing account, which is linked to a cash management account (or normal savings account).

Placing an order

When placing a sell order with a broker, have the Holder Identification Number (HIN) or Security holder Reference Number (SRN) read as this is proof of ownership of the shares and this enables the broker to authorise transfer of the shares to the new owner. When placing a buy or sell order, there are two ways in you can sell. Shares can be traded at “market order” which means the prevailing market price will be the price at which it executes. The alternative is the “limit order” which you set the minimum sale price or maximum buy price. In this case, it may end up that the sale price is greater than your minimum and the buy price lower than your maximum – it is the broker’s obligation to provide the best price, therefore you might get a better deal than expected.

Who are the shares bought from?

When shares are bought, they are either sold from an investor on the ASX or sold directly from the institution – in which the investor is participating in an Initial Public Offering (IPO) where the company sells their shares for the first time to investors.

IPOs - IPOs or new share floats are where companies raise new funds for the purpose of expanding the business. Once the company wishing to float registers information with ASIC (Australian Securities and Investment Commission), a Prospectus is issued to the public which details information about the investment. After reading through the Prospectus and deciding that the company is a sound investment, investors need to apply for shares by filling out a form and submitting it to the company with payment per share (based on an indicative amount).

At the close of the subscription/application period, depending on the popularity of the issue, it will be either over-subscribed or under-subscribed. Over-subscription will usually result in fewer shares being allocated to investors as more investors are applying for the limited amount of shares. Under-subscription usually results in investors getting their full application of shares as demand for the IPO is lower.

If the application of shares is under the amount of shares available to sell, the Underwriter of the issue is obligated to buy the remaining outstanding shares (if one is appointed). Note that there is not one price, but an indicative price range as the final price depends on “book” that matches the supply with the demand, which is usually managed by an investment bank. Sometimes, the price of the issue is not set until one day before the float on the ASX. Once new shares are issued and floated on the ASX, demand and supply forces will kick in and the price will move based on these market forces.

Listed Shares - There are more than 1800 companies listed on the ASX which investors can directly invest in. Existing shares have an advantage over IPOs in that demand and supply is transparent, linking to the liquidity of the shares (how quickly you can turn your investment into cash and the amount or volume which you can sell (the depth of the market)). Investors can see how many people are willing to sell and how many are willing to buy at specific prices – this transparency is advantageous over investments such as property which has few properties for sale and asking prices are not available.

However, it should be noted that different stocks have different levels of liquidity (or demand from buyers and sellers). Commonly, the large blue chip stocks have greater depth and liquidity, whereas the lower the market capitalisation (the market value of the company as calculated by share outstanding multiplied by the price) the lower the liquidity – thus this affects the ease of selling your shares. Liquidity also affects the price of shares: if the shares have low liquidity, investors put a premium on this, meaning the shares are more expensive as it is a disadvantage because it is marginally more difficult to convert the shares into cash.