Who’s Who in the Trading Zoo?

In Chapter 3, Larry Harris zooms out to give us the “big picture” of the trading industry. If you want to understand market microstructure, you first need to know who the players are and what they’re actually trading.

The Two Sides of the Coin: Buy Side vs. Sell Side

The trading industry is split into two groups based on who is buying the service of trading:

• The Buy Side: These are the people who need to trade. They have problems to solve—like moving money from the present to the future (investors), managing risk (hedgers), or just having fun (gamblers). They “buy” liquidity.
• The Sell Side: These are the people who provide the service. Dealers and brokers live here. They sell the ability to trade whenever the buy side wants to.

The Facilitators: The Invisible Machinery

When you trade, a lot of things happen that you never see. There’s a whole army of “trade facilitators” making sure you don’t get cheated:

• Exchanges: The meeting place. It could be a physical floor or a bunch of servers in a data center.
• Clearing Agents: They match the records. If the buyer says they bought at $10.01 and the seller says they sold at $10.02, the clearing agent flags the “out-trade” or “DK” (Don’t Know).
• Settlement Agents: They handle the actual swap of cash for shares. In the US, this usually happens in three days (T+3), though it’s getting faster.
• Custodians: Think of them as the high-tech vaults that hold the actual assets.

What’s on the Menu? (Instruments)

Harris breaks down what we’re actually trading into a few buckets:

1. Real Assets: Physical stuff like oil, gold, or even “pollution credits.”
2. Financial Assets: Paper that represents ownership. This is your typical stocks (equities) and bonds (debt).
3. Derivatives: Contracts that “derive” their value from something else. Options, futures, and swaps. These are “zero net supply,” meaning for every person who is “long,” someone else is “short.”
4. Hybrids: Weird combos like convertible bonds (a bond that can turn into a stock).

A Reality Check on Stocks

Here’s a fun fact: even though the news talks about the stock market 24/7, stocks only represent about 20% of the total wealth in the US. Most of the money is actually in real estate and bonds.

Many bonds and small stocks hardly ever trade. If you want to buy an obscure corporate bond, you can’t just go to an exchange; you have to call a dealer who might be the only person on earth willing to sell it to you.

In the next part, we’ll look at where these markets actually live and how they’re regulated.

Next Post: The Trading Industry (Part 2)