Although most of us think we know what stock exchanges are, our knowledge probably doesn’t go beyond a visual of a clanging bell in a big room, followed by a bunch of people in suits yelling at each other. As it turns out, it’s fairly more complex than that.
Stock exchanges are physical or online venues where investors can buy and sell shares of publicly traded stocks. They exist in major markets globally, giving investors access to companies on the global market.
In the U.S., there are two major exchanges: The New York Stock Exchange (NYSE) and the Nasdaq. Here’s a look at how these and other stock exchanges work.
How Does the Stock Exchange Work?
Stock exchanges function as a part of the wider global stock market. They typically work like auctions, allowing investors to buy and sell shares of stocks.
Share price is determined by supply and demand, and the price of the stock typically reflects how well traders think a company will do in the future.
Those who think a company will do well bid the price up, while those who think it won’t do well try to bid the price down. Sellers try to sell their stocks for as much as they can, while buyers typically look for the best deals they can get.
What Are the Different Types of Exchanges?
In an auction market, buyers and sellers are paired based on the lowest price the seller will accept for the shares of their stocks and the highest price the buyer is willing to pay.
When those two figures match up, a trade can take place between the buyer and seller. The matching pairs are put together and the buy and sell orders are executed. For example, say there are two sellers trying to sell shares of Company X, one for $10 and one for $10.50.
At the same time two buyers are trying to buy shares of Company X, one for $11 and one for $10.50. The seller and buyer offering $10.50 are paired together and for the moment the new price for the stock is $10.50.
The New York Stock exchange is a prime example of an auction market. The exchange does the pairing of buyers and sellers to make the process as efficient as possible, avoiding direct negotiations between buyers and sellers.
Electronic Communication Networks (ECNs)
ECNs allow investors to trade listed stocks and other exchange-traded products. They are required to register with the SEC and are classified as an alternative trading system (ATS).
To place a trade with an ECN, investors must be subscribers, and for the most part, only broker dealers and some institutional traders are allowed to become subscribers. Individual investors must have an account with a broker to place an order.
ECN systems allow investors the opportunity to trade outside of normal trading hours when the major stock exchanges are closed.
You may be familiar with electronic, or e-trading, already. This method of trading uses the internet to allow individuals to connect to a stock exchange or to an ECN.
The method became popular in the nineties and has swiftly replaced much of the traditional floor trading and phone trading that used to take place.
Electronic trading offers significant advantages over traditional trading, including the fact that it can be done remotely, so there is no need for brokers to be physically present at the stock exchange.
It’s fast—stocks can be bought and sold almost instantaneously. Electronic trading is also cheaper than traditional forms of trading. These savings may be passed on to individual investors in the form of low- or no-fee trading.
Over-the-counter (OTC) stocks tend to be cheap stocks offered by small companies that trade outside of the traditional stock exchanges. By not paying to be listed on the large stock exchanges, companies can keep stock prices down, helping to draw in investors.
OTC stocks are traded through a network of brokers and dealers outside of the major exchanges, such as the NYSE, and as a result, they are what is known as “unlisted.”
Various electronic platforms host OTC trades. One of the largest is the OTC Bulletin Board (OTCBB), which is operated by the Financial Industry Regulatory Authority (FINRA), a government-approved organization that helps protect markets and investors. All trades on this market are overseen by the organization.
OTC Link is another over-the-counter trading platform where investors can find smaller companies with lower trading volumes than those typically traded on the OTCBB.
Investors who want to trade OTC stocks will still need to go through a broker. Brokers may have higher fees for trading OTC stocks than for listed stocks, and trades may take longer than for stocks traded through an exchange.
Unlike companies traded on large exchanges which file reports with the SEC, some OTC companies may not have to file any kind of audited financial reporting. As a result, OTC stocks may require more research and due diligence before purchase.
What Are the Different Stock Exchanges?
There are two main stock exchanges in the United States: the New York Stock Exchange and the Nasdaq. Investors may also encounter the American Stock Exchange (ASE).
The New York Stock Exchange
The NYSE was founded in 1792 at 68 Wall Street. Twenty-four brokers and merchants signed the Buttonwood Agreement—named for the tree under which they gathered—to codify the rules for trading securities. The Bank of New York was the first stock listed on the exchange.
From its humble beginnings, the NYSE has now become the world’s largest exchange.
It became a publicly-traded company in 2006 and in 2007 it merged with Euronext, which combined the NYSE with five European exchanges, including the Amsterdam exchange, Paris Bourse, London International Financial Exchange, and the Brussels and Lisbon Exchanges.
The company acquired the American Stock Exchange in 2008. In 2013, the Intercontinental Exchange (ICE) bought the NYSE for $8.2 billion.
The NYSE is an auction market and allows electronic trades or trade through traditional floor traders.
These are the traders usually shown in popular portrayals of Wall Street. They use the outcry system of trading, utilizing verbal communication and hand signals to execute trades in the trading pit.
At an auction market, buyers set a “bid” price, the price they are willing to pay for a stock. Sellers set an “ask” price, the price for which they are willing to part with a stock. Brokers are representatives for the entity buying stocks.
A brokerage company acts of behalf of most individual investors. Brokers must be approved by the NYSE and they must be issued a trading license.
Dealers must also be approved by the NYSE and licensed. They play the role of matchmaker between brokers and stock sellers. For their trouble they collect the difference between the bid and ask prices. In electronic transactions, the computer acts as the dealer.
Companies must meet a number of criteria in order to be listed on the NYSE. For example, companies must have 400 shareholders and 1.1 million publicly held shares. They must also have a minimum share price of $4. The collective value of the shares must be equal to $100 million or more.
Companies must also pay annual fees to stay listed on the exchange. The largest companies may pay as much as $500,000 a year.
The NYSE opens at 9:30 a.m. ET with the opening bell , and closes at 4:00 p.m. ET. The opening and closing bells are often used to celebrate a financial event or an important New York City event.
For example, a company may be invited to ring the opening bell when it makes its initial public offering.
While the NYSE is a hybrid electronic and floor exchange, the National Associated of Securities Dealers Automated Quotations System, or Nasdaq, is electronic only.
It is the second largest exchange by market capitalization, which measures the total dollar value of the stocks traded there. Investors can use the Nasdaq to trade both listed stocks and OTC stocks.
Many tech stocks are traded on the Nasdaq, and because it offers lower fees for listing than the NYSE, it is also a place where companies that have little or no revenue may list first.
For example, biotech companies that are still in their development phases may choose to list on the Nasdaq for its cheaper fees and more lenient standards for listing.
The Nasdaq was created in 1971 by the National Association of Securities Details (NASD) as the first electronic market in the world. Initially, the newly formed Nasdaq couldn’t execute trades. Instead it was a facilitator of OTC trading. It later added automated trading and became the first exchange to offer trading via the internet.
In 2018, the Nasdaq bought the Stockholm-based OMX ABO, which operates Nordic and Baltic stock exchanges, for $3.7 billion. The move gave the company a greater foothold in the European market.
In order to be listed on the Nasdaq exchange, companies must meet a number of different financial and liquidity requirements.
Companies can be listed on one of the exchange’s three market tiers: The Nasdaq Capital Market for small cap stocks, The Nasdaq Global Market for mid cap stocks, or the Nasdaq Global Select Market for large cap stocks.
Listing requirements vary by market tier. Companies who wish to be listed on the Global Select Market are subject to the highest listing requirements, and those listed on the Capital Market are subject to the lowest listing requirements.
Like the NYSE, the Nasdaq is open from 9:30 a.m. to 4:00 p.m. ET. In addition, the Nasdaq offers pre-market hours from 4:00 a.m. to 9:30 p.m. ET and post-market hours from 4:00 p.m. to 8:00 p.m. ET.
Note that when people say “the Nasdaq” they are often referring to one of a pair of market indexes: the Nasdaq Composite Index and the Nasdaq 100. These should not be confused with the exchange itself.
The Nasdaq composite index tracks the performance of nearly every stock listed on the exchange and can be used to measure market advances and market corrections.
The Nasdaq 100 tracks the 100 biggest non-financial stocks that are listed on the exchange, and is widely focused on technology stocks. In fact, the Nasdaq 100 is often used as a barometer for the health of the tech industry as a whole.
The American Stock Exchange
The American Stock Exchange was once the third largest exchange in the U.S. Its members were originally known as “curbstone brokers” since they would trade on the street in front of the NYSE. Like the NYSE, the ASE is an auction exchange.
Historically, it attracted smaller companies from emerging industries that might not have met the stringent requirements for listing on the NYSE. The exchange has also been an important market for specialized investments, such as stock options and derivatives.
In 1998, the ASE merged with the Nasdaq while maintaining its own trading operations. It reverted back to its membership owners in 2003. And in 2008, it became a part of the NYSE group of exchanges.
Accessing the Stock Exchanges
Individual investors can access the NYSE and the Nasdaq through a brokerage firm, which typically offers a wide variety of services, including trading securities. Brokerage firms may be full service firms, discount firms or online only.
Which type of firm you choose will depend on your needs and the type of investor you are. If you plan on being a hands-on investor who is willing to research investments on your own, a discount or online broker may be the best fit.
Online brokers typically offer the lowest fees, so if you plan to trade frequently, you may want to go with this option to avoid paying too much in commissions.
To get started, investors usually have to open a brokerage account and fund it with cash. Brokerage accounts may have account minimums.
Most will allow you to open an account with $1,000 or so, though some may require minimum balances of $2,500 or more. This money can be used to buy securities and to cover whatever fees the firm charges to execute trades.
Note that some firms may have very low minimum balances and charge no fees to execute trades.
You can also access the stock exchanges through retirement accounts, such as 401(k)s and traditional and Roth IRAs.
To execute a trade, you can place an order online or over the phone with a broker, who can then make the trade for you.
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