Quick Answer
A quote shows the bid (highest buyer price) and ask (lowest seller price); the spread between them is an implicit cost when crossed. This unit covers four order types: market, limit, stop, and stop-limit. A firm acts as agent or principal, never both on one trade, and owes best execution either way.
The whole unit on one sheet: the vocabulary, the order types, who does what, and what trading actually costs.
Which One-Liners Win Points?
- Bid = highest price a buyer will pay; ask (offer) = lowest price a seller will accept; the spread is the gap between them.
- Narrow spread generally = high liquidity; wide spread generally = low liquidity. The spread is a real potential cost even though no one bills you for it.
- Market order: greatest certainty of execution (not guaranteed), not price. Limit order: guarantees price (or better), not execution.
- Stop order becomes a market order when triggered; stop-limit becomes a limit order when triggered.
- A buy limit sets a maximum purchase price (commonly below market); a sell limit sets a minimum sale price (commonly above market).
- Agent (broker) earns a commission; principal (dealer) earns a markup (selling to a customer) or markdown (buying from a customer).
- A firm charges a commission OR a markup on a given trade, never both.
Which Order Type Do You Use?
| Order | Placement | Purpose |
|---|---|---|
| Buy limit | Below market | Buy at a lower price |
| Sell limit | Above market | Sell at a higher price |
| Sell stop | Below market | Limit losses / protect profits on a long position |
| Buy stop | Above market | Limit losses on a short position / enter on breakout |
Which Numbers Matter Most?
| Item | Value |
|---|---|
| Regulation T initial margin (Federal Reserve Board) | generally at least 50% for a new eligible equity purchase |
| Maintenance margin (Financial Industry Regulatory Authority) | generally at least 25% equity for long equity positions |
| FINRA markup/commission guideline | generally should not exceed 5% of prevailing market price (not munis) |
Who Plays Which Role in a Trade?
- Broker-dealer: facilitates transactions; agent capacity earns a commission, dealer capacity earns a markup or markdown. Never both hats on the same trade.
- Custodian: holds and safeguards assets; handles settlement, record-keeping, and reporting (large banks). No investment decisions.
- Market maker: a dealer standing ready to buy and sell; profits from the bid-ask spread. NYSE assigns ONE Designated Market Maker per security (alongside other liquidity providers); Nasdaq has MULTIPLE competing market makers.
- Exchange: the regulated marketplace (New York Stock Exchange, Nasdaq, Cboe, formerly the Chicago Board Options Exchange). Exchanges are self-regulatory organizations under Securities and Exchange Commission oversight, not government agencies.
What Does Trading Cost?
- Commission: explicit cost on agency (broker) trades; must be disclosed on the confirmation.
- Markup / markdown: cost on principal (dealer) trades, embedded in the customer's net price; must be fair and reasonable.
- Bid-ask spread: implicit potential cost when crossing the spread; a round trip at unchanged quotes loses one full spread total (not the spread twice).
- Payment for order flow: compensation a broker-dealer receives from a market maker or other venue for routed orders (cash, rebates, or other benefits); must be disclosed and raises a conflict of interest (routing to the highest rebate rather than the best price).
Which Gotchas Trip Students Up?
- Cash accounts: paid in full by settlement, no borrowing, no short selling. Short selling requires a margin account and is subject to Regulation SHO (locate requirement plus order-marking, price-test, and close-out rules).
- Short selling has theoretically unlimited risk on an unhedged position because a stock has no fixed ceiling.
- The 5% markup policy is a guideline, not a hard rule or ceiling, and it also covers agency commissions but not municipal securities. Above 5% is not automatically a violation; below 5% is not automatically reasonable.
- A maintenance deficiency may prompt a margin call, but the firm can liquidate positions to protect itself without notifying the investor first.
- Best execution does not mean the absolute best price every time; it means reasonable diligence across factors like price, speed, likelihood of execution, and execution size. It applies to both principal and agency transactions, regardless of capacity.
- Introducing vs. clearing firm: the introducing firm holds the customer relationship, takes orders, and makes recommendations but does not hold customer cash or securities, settle, issue confirmations and statements, or extend margin. The clearing firm does all of that under a clearing agreement, and the customer must be told which firm does what.
- Fully disclosed vs. omnibus: fully disclosed means the clearing firm knows each customer's identity; omnibus means it sees only the introducing firm. Lower net capital requirements are the usual reason a firm introduces rather than clears.
One-Breath Recap
A quote pairs the bid (highest buyer price) with the ask (lowest seller price), and the spread between them is an implicit round-trip cost that generally widens as liquidity thins. Orders trade off execution against price: market offers the greatest certainty of execution (not guaranteed), limit guarantees price, a stop becomes a market order when triggered, and a stop-limit becomes a limit order. A broker-dealer wears one hat per trade, agent (commission) or principal (markup or markdown) but never both, while custodians safeguard assets, market makers supply liquidity off the spread, and exchanges provide the regulated venue. Lock in Regulation T's generally 50% initial margin from the Federal Reserve, FINRA's generally 25% maintenance floor and 5% markup guideline, and the rule that best execution applies to principal and agency trades alike.
Need more than the recap? Read the full Trading Securities unit.