Stock Exchanges

Stock Exchanges (What Are They and Why They Exist)

BY CHARLES JOSEPH



If you’re looking to get started trading stocks, you’ll need to become familiar with stock exchanges. They’re the heart of the stock market, where all the action takes place, and understanding them will be key to your trading success.

Here’s the lowdown on stock exchanges: what they are, how they work, and how to put them to work for you.

What Are Stock Exchanges?

Think of a stock exchange like a farmer’s market: a single location where many different vendors are given space and exposure to sell their wares to the public. The farmer’s market doesn’t actually sell anything itself — it just provides a platform over which the actual transactions can take place.

Tracking down and dealing with each vendor individually would be too much work for the average person. The farmer’s market acts as a middleman to connect seller and buyer, simplifying the process for both parties.

There are many different farmer’s markets out there, each with its own unique offerings — and its own requirements for new vendors. By vetting the vendors, the farmer’s market protects its patrons from scams and unfair practices, allowing them to shop with confidence.

That’s stock exchanges in a nutshell. Companies list themselves on various exchanges to connect with investors and sell shares, while investors use exchanges to find new stocks and easily trade shares with other investors.

How the Stock Exchange Works (for Dummies) [Video]

How Do Stock Exchanges Work?

When a company decides to go public — that is, to start selling shares of its ownership to public investors — it selects a stock exchange to be listed on. It must pay a fee to the exchange and meet the listing requirements, including figures like number of shares, annual income and company valuation.

If these requirements are met, the company is listed on the exchange. Buyers and sellers can then use the exchange to trade shares of the company amongst themselves.

This is known as the secondary market — where shares are traded between investors after their initial purchase from the company itself.

Stock exchanges are crucial to the secondary market because they collect all buyers and sellers in one place. This ensures that there are always plenty of buyers and sellers available to carry out trades, without requiring any additional legwork on the investors’ ends.

Exchanges also keep track of every transaction involving the stocks they sell. Most critically, they maintain a record of bids and asks — that is, the highest prices buyers will pay and the lowest prices sellers will accept.

What Are the Different Types of Stock Exchanges?

Stock exchanges can be categorized by the way in which they operate. The three main types are auction exchanges, electronic exchanges and over-the-counter markets.

Auction Exchanges

Before the digital age, stock exchanges were physical places where stocks were traded in person on the exchange floor. Brokers would seek each other out on the floor, calling out their bids and asks to a sea of other traders in the hopes of finding a match.

Today, much of the stock market is entirely virtual. But auction exchanges, such as the New York Stock Exchange (NYSE), still operate in person, keeping the traditional spirit of the stock market alive.

At auction exchanges, each stock is represented by a specialized broker on the floor. These brokers are known as Designated Market Makers, and their job is to match buyers and sellers like an auctioneer, calling out prices and updating records as matches are made.

Electronic Exchanges

Most stock exchanges have moved away from the auction system and gone fully electronic.

Electronic exchanges, including the Nasdaq, don’t have a trading floor or physical traders. Transactions are facilitated by computer programs that can complete transactions near-instantaneously, making them more efficient than auction exchanges.

In electronic dealer markets, traders called Market Makers own large inventories of stocks, setting their own bids and asks. These dealers are always ready to buy and sell stock, so other traders don’t have to wait to be matched with each other — they can buy or sell from the Market Maker with the best price.

Some electronic exchanges bypass dealers altogether, directly connecting buyers and sellers over an Electronic Communication Network (ECN). However, these aren’t typically used by individuals; they’re geared towards institutional investors who trade large quantities of stocks on behalf of other investors.

Over-the-Counter Markets

Many stocks don’t qualify to be listed on any major auction or electronic exchanges. They may not be big enough to make the cut, or they may have been delisted from a major exchange after scaling back or underperforming.

And some companies just don’t want to deal with the high fees and intense regulation that comes with being listed on an exchange. But they still want to open their ownership up to the public.

These stocks can be bought on over-the-counter (OTC) markets such as Pink Sheets, which have a lower barrier to entry for both companies and investors. But new investors should use caution: OTC markets may have cheap stocks, but they tend to be riskier than major exchanges due to their reduced oversight and regulation.

What Are the Biggest Stock Exchanges?

There are 60 stock exchanges around the world, but two of the biggest and most important are based in the U.S.: the New York Stock Exchange (NYSE) and the Nasdaq.

What Is the New York Stock Exchange (NYSE)?

The NYSE is the world’s largest equities exchange, boasting over 2,500 stocks and a market cap (total value of all stocks) of over $28 trillion. It’s headquartered on Wall Street in New York City, and it’s where the classic depiction of the stock market comes from: a bustling floor filled with brokers in suits, computers, marquees and clocks.

But the NYSE isn’t just an auction exchange anymore. Since 2007, it’s offered investors the ability to trade its stocks instantly via its electronic market.

Many of the world’s biggest companies are traded on the NYSE, including Walmart, Exxon Mobil, Pfizer and Coca-Cola.

What Is the Nasdaq?

The Nasdaq is America’s second-largest exchange, with a market cap of over $22 trillion. Unlike the NYSE, it’s entirely electronic, and it focuses mainly on tech and finance: over 3,000 companies in those industries are listed on it.

Apple, Microsoft, Alphabet/Google, Tesla, Facebook and Amazon are just a few of the biggest names listed on the Nasdaq. In fact, the Nasdaq’s offerings are so comprehensive that it’s used as a barometer to gauge the health and future of the tech industry as a whole.