The Trade Life Cycle: Explained in Plain English

Whether you’re among the 61% of Americans currently investing in the stock market or hoping to do so, it helps to have a game plan. And that starts with understanding what goes into the trading process. When you know the steps involved in executing a trade, you’ll be able to make appropriate plans before and after the trade.

Curious to know more? Read on to learn about the trade life cycle!

Pre-Trade Stage

Think of the trade life cycle as the process of actions that occurs during a trade. Anyone who is involved in trading as an investor or broker should understand the key steps.

That starts with knowing what happens during the pre-trade stage. The pre-trade stage establishes initial trading structures. And it considers risk and outcomes prior to executing a trade.

Before a trade even takes place, there should be clear procedures to protect all parties involved. And those procedures need to abide by regulations and established legal standards.

For institutions executing trades, the pre-trade stage is key. It creates internal processes to manage data from trades. Further, institutions need to have collateral management procedures and legal agreements in place.

From an institutional standpoint, the pre-trade stage also involves working with a client to understand their needs and risks. This is an onboarding step that is very critical if an institution wants to keep the client’s business.

A reputable institution will help a client assess costs associated with future trades. This can help develop a plan that is in line with their risk tolerance.

Trade Execution

During trade execution, the institution or brokerage working with a client will enact a trade. You can think of the trade execution as the point of buying or selling.

Clients may be seeking supplemental income. Or they might be looking to build funds for retirement along with an employer-sponsored retirement fund. An institution should understand the client’s motivations to offer trading guidance.

The institution handles the next steps for the client. But the client needs to submit orders for trades. As a result, the institution will need to know how time-sensitive each trade is.

For instance, a client may request that a trade happen right away. Others may require waiting until a stock hits a certain price. For institutions with many clients, those executing the trades need to have a system in place.

Trade Clearing

Next, the trade goes through a clearing process. In other words, the trade does not happen instantaneously.

In fact, the transaction undergoes several critical steps first. Knowing the terms and smaller steps along the way can make it easier to visualize this process.

For instance, the trade date represents when the trade agreement occurs. The value date is when the transaction’s value is officially determined and the monetary exchange occurs. This date also is when the trade goes through and settles.

Ultimately, the settlement date represents when the trade is completed. The settlement date often will align with the value date.

At this critical juncture in the life cycle, the institutions agreeing to the exchange will capture the details of the transaction. Such details will include the value of the trade. Details also will include legal language surrounding the transaction.

Institutions will conduct trade reporting to document the trade, too. Before the trade can be settled, both institutions will need to agree to the terms of the trade. All information will be captured for the institution’s records.

Trade Settlement

Trade settlement is part of the final stage of the trade life cycle process. Both parties involved in a transaction will exchange the money or securities needed to do so.

In delivery-versus-payment (DVP) scenarios, the exchange of funds happens at the same time. The DVP process is a low-risk situation as one party is not paying first and awaiting the other party’s payment.

In free-of-payment (FOP) processes, by contrast, the risk goes up. One party pays first. And they must then trust that the other party will make its payment at a later date.

During the trade settlement portion, institutions will need to pay associated fees, as well. These fees may include brokerage fees and transfer fees. They also can include fees for the use of given trade platforms.

Ultimately, the trade settlement process includes everything from the trade execution to the settlement. Clients need to be sure that the institution doing the trade on their behalf has procedures in place for a safe transaction.

Risk Management

Finally, investors need to think about their long-term journey. In other words, how much risk are they willing to accept with stock trades? Working with My Investing Club, you can get the education you need to make wise financial decisions.

Clients should determine what kinds of losses they can withstand financially. After all, the stock market can behave like a roller coaster. Clients may want to determine how much of their portfolio they want to devote to stocks versus bonds and other investment options.

Many institutions will evaluate risk management during the trade settlement process, too. For instance, they might look at the trade valuation to ensure that the trade is a good decision. Or they might conduct a cost analysis to show how the trade affects a client’s bottom line.

But clients should consider risk management independently, as well. And this needs to be an ongoing process. As a client’s portfolio expands and their wealth grows, their risk tolerance may decline.

By contrast, a client looking to amass wealth more quickly may be willing to make riskier trades. All of this information should be part of a regular conversation between the client and the institution executing their trades.

Understand the Trade Life Cycle

Knowing how the trade life cycle works can impact your approach to making trades. You’ll need to choose a reputable institution that can complete the trade execution and clearing process without a hitch. And be sure that you’re paying attention to your risk tolerance as you plot future trades after the last one settles.

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