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 they trade stocks . As it turns out, it’s fairly more complex than that.
Stock exchanges are physical, electronic, 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.
A Look at How a Stock Exchange Works
Stock exchanges function as a part of the broader global stock market. They typically work like a marketplace, allowing investors to buy and sell shares of publicly-traded companies.
Additionally, stock exchanges play a vital role for companies that want to raise money by selling shares to the public through an initial public offering (IPO). These companies can then put the capital raised back into the business, while investors who buy shares can ideally profit from their investment.
The stock exchanges, along with government entities that regulate securities trading, set rules and regulations for what companies can trade on the exchanges. These guidelines provide safety for investors and help ensure that the market is fair and transparent.
Investors who want to trade stocks do so through an investment broker, a person or firm licensed to trade on a specific stock exchange. Investment brokers try to buy or sell stock at the best price for the investor making the trade, usually earning a commission for the service. Most investors will now use an online brokerage firm for this service, paying little to no commissions for transactions.
A stock’s 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 believe it won’t do well often push the stock’s price down when they sell.
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What Are the Different Types of Exchanges?
Auction Markets
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 two sellers are 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)
Electronic communication networks (ECNs) allow investors to trade listed stocks and other exchange-traded products. They are required to register with the Securities and Exchange Commission (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 to trade outside regular trading hours when the major stock exchanges are closed.
Electronic Trading
Electronic trading uses the internet to allow individuals to connect to a stock exchange or 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 through low- or no-fee trading.
Over-the-Counter
Over-the-counter (OTC) stocks tend to be cheap and offered by small companies that trade outside of the traditional stock exchanges. By not paying to be listed on large stock exchanges, companies can keep stock prices down, helping to draw in investors.
OTC stocks, sometimes called penny stocks, are traded through a network of brokers and dealers outside the major exchanges, and, as a result, they are known as “unlisted.”
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 those 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 audited financial reporting. As a result, OTC stocks may require more research and due diligence before purchase.
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What Are the Different US Stock Exchanges?
There are two main stock exchanges in the United States: the New York Stock Exchange and the Nasdaq.
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 NYSE has become the world’s largest exchange since its humble beginnings.
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 trading system, 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 they are willing to sell a stock.
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A brokerage company acts on behalf of most individual investors. The NYSE must approve brokers and be issued a trading license.
Dealers, sometimes called market makers, must also be approved by the NYSE and licensed. They play the role of matchmaker between brokers and stock sellers. They collect the difference between the bid and ask prices for their work.
Companies must meet several criteria to list 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 equal $100 million or more.
The Nasdaq
The National Association of Securities Dealers Automated Quotations System, or Nasdaq, is an electronic-only stock exchange. It is the second largest exchange by market capitalization, which measures the total dollar value of the stocks traded there.
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 with little or no revenue may list first.
For example, biotech companies 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 online trading.
Companies must meet several financial and liquidity requirements to be listed on the Nasdaq exchange.
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When people say “the Nasdaq,” they often refer 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 on the Nasdaq exchange.
Both indices are heavily weighted toward the technology sector. Analysts often use the Nasdaq Composite as a barometer for the tech industry’s health.
Other US Exchanges
The NYSE American, formerly known as the American Stock Exchange (AMEX), 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.
Historically, it attracted smaller companies from emerging industries that might not have met the requirements for listing on the NYSE. The exchange has also been an important market for specialized investments, such as options and exchange-traded funds (ETFs).
Other U.S. Exchanges include:
• Philadelphia Stock Exchange, now known as Nasdaq PHLX, was the first official securities exchange in the U.S when it was founded in 1790. The exchange now focused on options trading.
• Boston Stock Exchange, now known as Nasdaq BX, was founded in 1834.
• NYSE Arca is an electronic securities exchange that facilitates the trading of ETFs and equities.
International Stock Exchanges
Though U.S. investors generally focus on stocks that trade on the NYSE and Nasdaq, there are many other stock exchanges throughout the world.
| 10 Largest Stock Exchanges by Market Capitalization of Listed Companies | ||
|---|---|---|
| Exchange | Location | Market capitalization (in billions)* |
| New York Stock Exchange (NYSE) | U.S. | $24.68 |
| Nasdaq | U.S. | $19.5 |
| Shanghai Stock Exchange | China | $7.05 |
| Euronext | Europe | $5.90 |
| Tokyo Stock Exchange | Japan | $5.31 |
| Shenzhen Stock Exchange | China | $5.15 | Hong Kong Exchanges | Hong Kong | $4.57 |
| National Stock Exchange of India | India | $3.32 | London Stock Exchange | U.K. | $3.17 |
| Saudi Stock Exchange | Saudi Arabia | $3.15 |
| *As of July 2022; Source: Statista | ||
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The Takeaway
It helps to know how stock exchanges work if you want to be a well-rounded investor. By learning about the different stock exchanges and their rules, you can better understand the stock market. This knowledge can help you make investment decisions, from investing in large stocks trading on the NYSE or Nasdaq to trading penny stocks over-the-counter.
If you want to start buying and selling stocks that trade on the NYSE and Nasdaq, SoFi can help. With the SoFi app, you can start trading stocks, ETFs, and fractional shares with no commissions for as little as $5. All you have to do is open a SoFi Invest® online brokerage account.
FAQ
What is a simple definition of a stock exchange?
A stock exchange is a marketplace where investors, brokers, and market makers can buy and sell shares of publicly-traded companies.
What is the difference between a stock exchange and the stock market?
A stock exchange is a physical or electronic marketplace where traders can buy and sell stocks. The stock market is a collection of all the stocks traded on all the stock exchanges.
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