Capital Markets: Trading on the Stock Exchange

As the preceding pages suggest, securities trading takes place exclusively on the stock exchange. Such trading cannot be conducted by an individual. Licensed professional intermediaries are required, i.e. brokers or brokerages, members of the stock-exchange. The trading process starts with investors, who want to buy or sell shares. Upon coming to a brokerage, they must first sign a "General Contract on Mediation" with the brokerage. This contract is signed only on the first visit and is the basis for issuing instructions (naturally, as long as the brokerage does not change).

When giving a buying order, advance payment for the shares to be bought must first be made to the brokerage's account. When selling shares, the brokerage may ask for the Securities Register's certificate of the status of the client's account. Once an order has been placed, the brokerage issues a receipt for the order. On most stock exchanges in the world the trade proceeds electronically, without the brokers being physically present at the Exchange. Brokers are connected to the Stock-Exchange trading system (BTS) through their workstations. The basis of the electronic trading concept is the electronic order book. The order book can best be described as a table where one writes all one's buying orders in the left column, and selling orders in the right one. The orders are ranked by means of so-called ‘price-time priority,' which implies that the more reasonably priced orders (reasonable on the buying side = higher price; reasonable on the selling side = lower price) have a greater priority in the order book. If two orders are identically priced, the one entered in the order book earlier has greater priority. The order in the book determines the order of fulfillment - the higher-ranked orders will be fulfilled before the lower-ranked ones.

On BiH stock exchanges, trading proceeds by means of the continuous method (MFTS - Multi-Fixing Time Schedule) and by periodical prevailing price auctions. Trading takes place five times a week - on workdays. How trading in a given symbol goes is determined by the liquidity of these shares. Liquidity in this context does not refer to the company's financial liquidity, but to the liquidity of shares. Greater liquidity implies more frequent (daily) trading in the shares, with small fluctuations, and the existence of a deep order book. On the other hand, small liquidity is characterized by a low intensity of trade (sporadic), with larger fluctuations in share price and few orders in the symbol's order book.

Low-liquidity shares are traded by auction. This method involves all the orders being collected in the order book until the specified moment or auction. Orders are not fulfilled, regardless of possible matches between some orders' prices. This allows the market more information. The basic aim of concentrating orders in this way is to reduce information asymmetry, which is very prominent in low-liquidity shares. Another characteristic of auction trading is that all transactions are performed at the auction price.

In the MFTS method, transactions are made automatically, as soon as the buying and selling orders match in price, so that a single security may have more than one price in the course of a single day. The official rate is the weighted average of all the closed transactions for a day, except for applications. This schedule is used for trading in the shares of issuers on the Quotation and Primary Free Markets.

Another difference between these two approaches is that some kinds of orders cannot be used in auction trading. In revising the MFTS, when some symbols move from MFTS to auction, brokerages have to contact clients with conditional orders to have them withdrawn and, where appropriate, different orders entered.

Another form of stock-exchange trading is special auctions, which can be used by the state, investment funds, and other investors who want to sell a given security package. For investors who are neither the state nor an investment fund, the offered quantity must be no less than 5% of the issuer's total number of issued securities. The stock exchange informs actors in the market and the public of the auction date, the offering party, and the price and quantity of the securities.

The methods used include the prevailing price method and the multiple price method. In the prevailing price method, the selling order is entered on the first day, whereupon it is possible to enter buying orders. In the multiple price method, the first day of entering is determined by the issuer. Public offers through the stock exchange may be considered a more modern and transparent way of entering securities than the traditional one, where entry is made by signing a statement on entry with the depository bank.

In BiH, members of the stock exchange can also deal outside the organized market - so-called ‘block deals.' The lowest value of a block transaction is 500,000 KM. Persons participating in a block transaction must agree a mutual contract of sale for the given shares before reporting the transaction to the stock exchange. Although the block of transactions is reported to the stock exchange, the price at which the transaction is reported does not affect the formation of the price for the given security. Third persons cannot buy securities from the block transaction, so as not to affect the price at which it will be closed.

It should be noted that there is also an OTC (over-the-counter) market, where the parties to the trade cooperate without using the services of the organized stock exchange. One of the largest world stock exchanges, the NASDAQ, still calls itself an OTC market.