Saxo Group
All trades go through a series of processes to ensure that all parties meet their obligations. This is known as the trade life cycle and, even though it occurs in the background, it’s important to understand what it is and how it works. This guide outlines how an order goes from being made to its completion.
The trade life cycle is a series of processes a trade goes through from start to finish. It’s the steps that need to be completed for a trade to be officially executed. This means the trade life cycle is important for the legitimacy and health of a financial market.
Specifically, without this process, the financial markets wouldn’t function in an efficient and orderly manner. While the trade life cycle happens “in the background”, as a trader you don’t have to worry too much about the details, but it’s important to understand how it works.
Think of it like this: you’re the customer buying something from a shop. You get to choose from a variety of things in a shop, but you don’t see the processes that went into getting them there. These processes are part of the product’s life cycle, but all you see are the things you can buy.
The trade life cycle is similar. However, the difference is that the trading life cycle considers processes that happen once you’ve placed an order (i.e. bought something).
Various processes ensure a security gets listed on an exchange. These processes include due diligence checks, compliance documents, and other legal processes.
Once a security is listed on an exchange, that’s when the next part of the trade life cycle begins, i.e. the security is available to the public.
There are six main processes you need to be aware of. Again, you don’t have to do anything other than place an order. Everything happens in the background. However, it’s important to understand the trading process so you can see how orders are managed and why they’re safe.
There are six stages to the trade life cycle. We’ll explain each stage, but first let’s quickly list them in bullet point form:
There are some subtle nuances at each stage in the process, but these are the main steps a trade goes through when you place a buy or a sell order via a broker (the bridge between you and a financial exchange).
There are some situations where it’s possible to place an order directly with an exchange. However, it’s common practice for traders and investors (i.e. you) to place an order with a broker. The broker sends a request to the exchange, and the order is completed. When the trade is active, it’s listed in your brokerage account, and you can manage it from there.
Now let’s look closer at the six stages of the trading lifecycle and the role they fulfil in completing buy and sell orders:
This is the stage where you decide what security you want to buy or sell. With trading, you can take a long position, which means you’ll make a profit if the security’s value increases. Alternatively, you can take a short position and make a profit if the security’s value decreases.
Whatever security you choose to trade and whatever position you take, the decisions should be based on research and data. Once you’ve decided, you can use trading software to place an order. From there, the next stage of the trade life cycle takes place.
Your order gets passed through a series of risk assessments. These are in place to ensure the trade is both safe and viable. These assessments are there to make sure a trade doesn’t carry too much potential risk for you as a trader.
Risk is a natural part of trading, and any order can make a profit or loss. However, a risk-assessment looks at whether a trade will put you in unnecessary financial danger. For example, this would include making sure your account has enough funds to allow a purchase.
Once your order has passed a risk-assessment, it’s time to find a match. This is when your order gets passed to an exchange. A financial exchange is a marketplace where counterparties are matched. A counterparty is a person/entity that’s willing to take the other side of a trade.
So, if you’re looking to buy a security, a counterparty is the person/entity that’s selling. If you’re selling, the counterparty is a buyer. The exchange finds a suitable counterparty based on the parameters of your order.
A post-trade confirmation notice is sent back to the broker once the exchange has found a suitable counterparty. Because of the way trading works, each counterparty will use a broker (except for rare situations where one or both is placing orders directly via an exchange).
That means the confirmation is sent to the broker/s handling the buyer and the seller requests. The buyer and seller could be using the same broker or different brokers. This doesn’t really matter. The only thing that matters is that brokers confirm the trade once notification is received. Once the exchange receives confirmation, the order goes to the clearance stage.
A clearinghouse reviews and clarifies the terms of a trade before the final stage of the trade life cycle is complete. The clearinghouse is an intermediary that checks the obligations of the buyer and seller.
These are the terms of a trade and, assuming everything checks out, it’s given a transaction number. From there, the trade is given a settlement date. This usually occurs two days after the initial transaction took place.
This is the final stage of the trading life cycle and it’s where funds are formally exchanged. The important thing to note here is that you don’t send the funds directly to the counterparty. The money will have already been deducted/added to your account, depending on whether you’re buying or selling.
The exchange of funds happens between the brokers. Any problems are rectified after the fact, but the point here is that brokers handle the settlements. All you see on the front-end is the money leaving your account or coming into it after a trade is confirmed.
This is also known as trade and settlement, and depending on the exchange, the settlement may happen days after the trade.
The trade life cycle is an important system of processes that ensures buy/sell orders are verified by all parties. Those parties are you, a broker, an exchange, and a clearinghouse. It’s a chain of command that starts with you placing a trade. Everything else happens in the background.
All you see is that an order has been received and confirmed.
After that, funds will be added to/deducted from your trading account. This can happen within a few seconds if you’re trading in a high-liquidity market such as stocks or forex. The process can take longer if liquidity is low or you’ve set specific parameters for your trade, such as a set price you want to buy/sell for.
However, in general, trades are executed in a fairly short period of time. That’s thanks to the processes an order goes through. Because there is a framework in place, everything flows seamlessly unless there’s a problem. The result is an efficient process between you, a broker and an exchange.
So, whenever you trade online, you can be confident that every transaction will be safe, secure and verified by multiple parties.
What is OTC trading? How to trade securities over-the-counter
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