Editor’s note: This the first segment of a four-part look at stock markets in the U.S. and around the world.
We take a lot of things in life for granted. Turn on the faucet and you expect water to run. Flip on the wall switch and you expect electricity to power your lights. Tap the big green button on your brokerage app and you expect to see stock in your account.
But on the back end there’s a complex web of exchanges and financial players—an ecosystem we often refer to as the “stock market”—that works together in order to facilitate that trade. Let’s look at who’s who and what’s what behind this process.
What Is a Stock and Why Do We Need a Market?
A share of stock represents ownership in a company, essentially a claim on corporate earnings and assets. Shares can be bought directly from a company in the primary market—usually through an initial public offering, or IPO—but after that, the company has no obligation to buy or sell their shares back to investors. This is where the secondary market comes into play.
In the secondary market, traders, investors and intermediaries trade equities between and among themselves. The majority of these transactions take place on a stock exchange. Without a robust and active secondary market, stocks would likely trade less frequently and become more illiquid, creating wider bid and ask spreads and potentially higher transaction costs.
What Is an Exchange, and Who Are They?
In the United States, two of the most well-known stock exchanges are the New York Stock Exchange (NYSE) and the NASDAQ. The role of a stock exchange is to facilitate fair and orderly trading for all participants as well as to provide real-time, transparent pricing information for listed stocks. The NYSE, a subsidiary of the Intercontinental Exchange Group (ICE), has a physical trading floor where a portion of trade volume is conducted, while the NASDAQ is all electronic. Other electronic marketplaces include BATS and IEX.
There are also several exchanges listing options on equities, such as the Chicago Board Options Exchange (CBOE), which recently acquired BATS. NASDAQ and NYSE also operate options exchanges. All U.S. stock and options exchanges are regulated by the Securities and Exchange Commission (SEC).
CME Group, which owns the Chicago Mercantile Exchange, Chicago Board of Trade, NYMEX, and Comex, lists futures contracts and options on futures, covering asset classes such as stock indices, currencies, interest rates, agricultural commodities, energy products, and metals. ICE also lists some soft commodity, energy, and financial futures and options. Futures and options on futures are regulated by the Commodity Futures Trading Commission (CFTC).
Who Are the Main Players?
- Individual investors: Often referred to as “retail investors,” most of their trades are placed through a brokerage. This category typically includes day traders as well as long-term investors.
- Institutional investors: These are the people who buy and sell stocks for mutual funds, index funds, public pension funds, and private funds such as hedge funds.
- Specialists: On some exchanges such as the NYSE, specialist firms are present to facilitate a fair and orderly market. They do so by acting as dealers, buying and selling stocks for their own account, and using their inventory to make a two-sided market in a particular stock.
- Market makers: Most exchanges also have market makers to facilitate trading. Market makers may be individuals, proprietary trading groups, or trading desks affiliated with banks and investment banks. Much of this trading involves complex algorithms that exploit small price discrepancies across exchanges in fractions of a second, which some say has helped retail investors receive greater liquidity and tighter bid-ask spreads in recent years.
Exchanges Are Worldwide
Although some U.S. stock exchanges are household names, the stock exchange isn’t a U.S. invention, and some foreign exchanges post significant trading volume. The Amsterdam Stock Exchange, created by the Dutch East India Company in 1602, is considered the first stock exchange, although the London Stock Exchange traces its roots back to the 1571 Royal Exchange.
Nowadays, almost every country in the world has its own stock exchange, sometimes called a bourse, though in some cases a regional stock exchange will account for most of the trading volume across a geographic area. Future articles in this series will take a more in-depth look at stock exchanges around the world and how they interrelate with the global financial markets.
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