What is a stock exchange? You’ve got questions – we’ve got answers

Being a crucial part of the global economy, stock exchanges are the driver of trading activities and business development. We have all heard about the stock trade but not everyone understands how this whole thing works. In this comprehensive guide, we will help you embrace this concept and answer all common questions concerning stock exchanges, their classification, how they work and help traders, and so much more. 

What is a stock exchange?

The stock exchange is an organization that allows investors and traders to carry out transactions with securities. It provides control over the participants and guarantees fairness and speed of transactions. Each completed transaction is subject to registration.

There are different classifications of exchanges. Basically, they differ by the following characteristics:

  1. Type of goods. In addition to stock exchanges, there are commodity, cryptocurrency and fiat currency trading platforms. A stock exchange allows participants to trade securities. On commodity exchanges, they handle real goods (agricultural products, oil, gas, precious metals). There are also the so-called derivatives markets – these are the markets in which industrial financial instruments (futures, options, etc.) are traded.

  2. Form of participation. There are two types of stock exchanges – open and closed. On open exchanges, transactions can be carried out by sellers, exchange members, and buyers. On closed ones, only members of the stock exchange have the right to trade.

  3. Organization. Most of the existing exchanges are joint-stock companies. The exchanges can also be of a mixed type if the shareholder is the state in addition to private companies.

  4. Role in world trade. There are national and international stock exchanges. National exchanges are relatively small, and they trade securities of small companies that do not meet the requirements of international exchange.

History of stock markets

The history of the emergence of the first exchanges refers to European countries, primarily Belgium, the Netherlands, Italy, Great Britain. The reason for the formation of exchanges is associated with the appearance of the first government bonds, which created the conditions for the functioning of the stock market. To attract additional funds, the state began to issue bonds. These assets were placed in the domestic and foreign markets.

Back in 1531, the first stock exchange appeared in Belgium (Antwerp). Brokers and moneylenders met there to deal with business, government, and even individual debts. The first prototype of the stock exchange dealt exclusively with bills of exchange and bonds since in the 1500s, there were no real stocks. 

In 1602, the Netherlands East India Company officially became the world’s first publicly-traded company by listing its shares on the Amsterdam Stock Exchange.

The development of the industrial economy in England in the 17-18th centuries stimulated the creation of the English exchange. At that time, new economic forms began to appear, issuing shares. The London Stock Exchange appeared in 1773 for the sale of securities. However, since companies were not allowed to issue shares until 1825, there was an extremely limited turnover on the London Stock Exchange. That prevented LSE from becoming the largest stock exchange in the 19th century.

In 1792, the New York Stock Exchange (USA) was founded by 24 brokers who signed the first brokerage agreement. In 1882, the Chicago Stock Exchange appeared in the United States. The exchange began to flourish significantly in the late 1880s when the number of transactions in stocks and bonds increased and brought them more profits.

The Bombay Stock Exchange was the first-ever stock exchange in Asia  – it appeared in 1875. Following its lead, the Tokyo Stock Exchange was opened in 1878 to provide Japan with the trade of government bonds that were issued for the samurai, a particular cluster of society. In 1891, American, British and French businessmen established the Shanghai Stock Exchange.

In Russia, the first exchanges appeared during the reign of Peter I. In 1705, the first Russian stock exchange was established in St. Petersburg. But it was far from being called an efficient market since trading at that time was carried out in small volumes and the credit system was poorly developed. Mostly, the bills of state factories were traded.

How stock exchange works

Many people imagine the stock exchange as a place shown in cinema – a bunch of people screaming and talking by phone. Previously, there was a physical trading floor, and the bidders shouted offers to buy and sell. Now, most of the trading activity is going online.

Each transaction made on the stock exchange goes through several stages: 

  1. Application. The buyer can leave a request via the Internet or by phone call. Their buy or sell order enters the electronic system.

  2. Reconciliation. All parameters of the transaction are carefully checked both by the investor and the seller of securities.

  3. Clearing (so-called mutual settlements that occur on the exchange). The transaction is being checked, and all the paperwork takes place.

  4. Transaction completion. At the last stage, the securities are directly exchanged for the investor’s money.

It is worth noting that there are certain periods of time in the stock market during which it is possible to make purchase and sale transactions. For example, some exchanges do not work on weekends.

Functions of a stock exchange

The exchange maintains fair pricing for the securities market and serves to connect buyers and sellers. All issuers are required to submit their financial statements to the exchange before being admitted to trading. Transactions take place at a certain time in accordance with the rules established on the exchange. Information about them is in the public domain, you can find it on the website of the corresponding exchange.

As for the stock exchange’s major functions, those include:

  1. Creation of a permanently operating securities market.

  2. Reallocation of funds between countries, different sectors of the economy and industry within one country, as well as between individual organizations.

  3. Fixing the investor’s share in a particular stock.

  4. Providing market liquidity and executing trades in exchange for transaction fees.

Important participants on stock exchanges

Every minute, a large number of operations are carried out on the exchange. Several types of participants are involved at once:

  • Investor. An investor can be both a legal entity and an individual. Its purpose is to invest in order to make a profit. To achieve their financial goals, an investor can buy and sell stocks, bonds, mutual funds, futures or other stock market instruments.

  • Issuer. It issues securities for raising capital. It can be a company, a city, or even a state. The exchange serves as a marketplace for them.

  • Broker. Acts as an intermediary between the issuer and the investor. When making transactions on the market, brokers act exclusively on behalf of the investor. The investor, in turn, has no right to carry out any transactions on the exchange without concluding an agreement with a broker and opening a brokerage account.

  • Registrar maintains a register of all securities. Thus, the company knows who became its shareholder.

  • Custodian stores securities and also keeps records of the right transfer when concluding transactions.

  • Regulator. In many cases, it’s a Central Bank. It also issues licenses to control the actions of participants in the securities market. It helps to protect investors from unscrupulous companies.

Primary and Secondary Market

On the primary stock market, the first issued securities of enterprises and the state are sold. This market is dominated by over-the-counter transactions. Securities are bought mainly by credit and financial institutions. 

The primary market is interconnected with the secondary market, where market participants buy and sell previously issued securities and their additional reserves. Stock exchanges play an important role in the capital market: they get capital together without government intervention and channel it into investments that promise a high income.

Types of Stock Exchanges

Auction Market

In these exchanges, buyers and sellers come up with competitive bids and offers. Market makers want to sell assets at a higher price, takers – but at a lower price. When buy and sell orders are matched, deals are executed. Today, this matching is done automatically by electronic algorithms and used by some exchanges, including New York Stock Exchange.

Dealer Market & Brokers

A broker is a company that mediates between private clients and major financial institutions and provides traders with access to a platform where they can buy and sell currencies, stocks, precious metals and other assets.

As a rule, a retail investor cannot access a stock exchange without the assistance of a broker.

Representatives of this market include major Forex brokers and banks that have exchange trading departments.

Electronic Stock Exchanges

As its name suggests, there is no manual physical activity and no trading floor – orders are matched by an electronic trading algorithm. These exchanges are faster and more efficient. They can process transactions worth billions of dollars within a day. The Nasdaq and ECNs (Electronic Communication Networks) are the most prominent stock exchanges in this sphere.

OTC Markets

This is a general term for all stock exchanges other than described above. Over-the-counter (OTC) usually lists small companies, issuers that were delisted from large exchanges, and other securities.

Stock Exchanges and IPOs

IPO (short for Initial Public Offering) is an initial public offering, the process of a private company or early investors selling stocks on stock exchanges, as a result of which the company becomes public and the securities are available to a wide range of investors. The list of intermediaries in this transaction includes underwriters, stock exchange, brokers, auditors, PR services, legal support, etc.

The sale of company shares is not just an alternative to debt financing, which burdens the company with regular interest payments. It is a step to a new level: along with the status of a public company, the issuer receives many other advantages by entering a stock exchange.

  • Improving reputation with partners and creditors.

  • Possibility to raise capital for further development.

  • Ability to determine the market price of a business.

  • Greater business transparency, which increases efficiency.

  • Subsequently, the company can conduct secondary market placements to finance new investment projects and achieve wider diversification.

  • The liquidity of securities and the ability to determine the market price allow you to use your own shares as an alternative to money, pay bonuses to employees, etc.

However, along with this, the company acquires many additional obligations, both to thousands of new investors and to regulators.

World’s Major Stock Exchanges

American Stock Exchange (AMEX)

It was created when the market only started shifting from the street to the premises. For a long time, AMEX had been specializing in the sale of low-liquid securities. In 2008, it was purchased by the NYSE stock exchange. 

New York Stock Exchange (NYSE)

This is the world’s largest stock exchange, its turnover reaches 50% of the total turnover of the world stock exchanges. NYSE is a non-commercial organization trading over 3,000 companies from all over the world. The rumor goes, listing requirements for NYSE are the toughest and most demanding in the world. 

London Stock Exchange

It was created by a stock company selling its own securities. Of the 22 stock exchanges in Belgium, only the LSE became the international stock exchange and the leading one in Europe. Before the First World War, it was one of the world’s leading stock exchanges. Both individuals and state brokers can become a member of the trade market.

Shanghai Stock Exchange (SSE)

This is the largest stock exchange in China, the leader of the Asian stock market. It is not a commercial organization and should be monitored by a security committee. The status of all listed companies on the stock exchange is used in the calculation of the SSE Composite index.

Nasdaq Stock Exchange

Nasdaq is an American stock exchange specializing in high-tech stock. The NASDAQ Index is an OTC market index published by the National Association of Securities Dealers and based on its quotes.

The composite NASDAQ index is based on the weighted market value of stocks of high-tech issuers. This means that each company’s security affects the index in proportion to the company’s market value. During the trading session, the Nasdaq index calculates the market value of more than 5,000 companies.

What are the biggest stock exchanges in the US?

Major stock exchanges in the US are NASDAQ, AMEX and NYSE. NASDAQ is the world’s first electronic stock market (more than 4,400 companies are trading here) – it offers stocks by Microsoft, Intel, Apple and Google. The international stock exchange (NASDAQ) also focuses on cooperation with the companies of the IT sector. 

How Do You Invest In Stock Exchanges

Profit on the stock exchange does not depend on luck as inexperienced traders think. The income depends on many factors: strategy, market trends, state of the economy. One way or another, profit can be predicted.

Here’s a short example to illustrate how trading on stock exchanges works:

  1. You buy and sell stocks and corporate bonds.

  2. Over time, shares rise in price or fall in price, income is brought by their timely sale and purchase. 

  3. Some stocks can bring you dividends, bonds give income in the form of guaranteed interest – coupons. Bond yields are smaller but more reliable.

Your profit will also depend on the chosen strategy. Generally, the higher the yield, the higher the risk of losing money. In the stock exchange, the yield can be higher than on deposits. But it is important to keep in mind that no one gives guarantees.

Since investments in securities are not insured, you run the risk of losing some, and sometimes all, of your investments. Never invest more than you can afford to lose.

Pros and cons of stock exchanges

With this information in mind, you will be able to weigh all risks and profits to trade wisely in LiteFinance or another platform.

Advantages of stock exchanges

Disadvantages of stock exchanges

A stock exchange enables publicly traded companies to attract investment capital for business development fueled by the maximum possible number of investors.

Risk of speculation. Large market players (whales) can provoke price movement in the direction they need (first of all, in assets with low liquidity). The movements on the stock exchange can be spontaneous and impossible to predict.

They provide liquidity and drive the very process of buying and selling securities, while ensuring issuer and investor protection. The algorithms of the world’s leading stock exchanges are transparent and understandable.

Trading on a stock exchange is risky like any other investment. Having limited financial knowledge, traders can lose money. 

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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