What is the Stock Market?
The stock market is where buyers and sellers come together to trade shares in eligible companies.
🤔 Understanding the stock market
Stocks are bought and sold on stock markets, which bring together buyers and sellers of shares in publicly traded companies. Stock markets operate kind of like auctions, with potential buyers naming the highest price they’re willing to pay (“the bid”) and potential sellers naming the lowest price they’re willing to accept (“the ask”). The actual execution of a trade price will be somewhere at or between the bid and the ask. Trades can be placed by stockbrokers, usually on behalf of portfolio managers or individual investors like you. In the US, the stock market is made up of 13 exchanges—the best known are the New York Stock Exchange and the Nasdaq.
Snap Inc., parent company of Snapchat, listed its shares publicly with its 2016 IPO. Shares now trade on the New York Stock Exchange under the ticker symbol “SNAP.”
Stock markets are complex, but they’re all based upon one simple concept...
From New York to Hong Kong, every stock market helps connect buyers and sellers, who trade under an agreed upon set of rules.
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- Primary functions of the stock market
- Are there risks to the stock market?
- When people say “the stock market rose,” what do they mean?
- How does the stock market work?
- Who uses the stock market?
- Who are the participants in the stock market?
- Who regulates stock markets?
- What are some rules of the stock market?
- What are some examples of stock markets?
- What is the origin of the stock market?
- What is the history of the modern stock market?
Primary functions of the stock market
The stock market is where the general public can access stocks of publicly traded companies. They function kind of like a farmers’ market, with buyers and sellers meeting in one place to exchange things. But stock markets are much more complex and regulated, with prices that can change rapidly. Here are three key activities you’ll find on a stock market:
- Stock buying: Both everyday retail investors and sophisticated institutional investors can purchase shares of companies.
- Stock selling: Every stock trade has a buyer and a seller.
- Issuance of stocks: If a private company wants to raise money, it may agree to sell a portion of its ownership on the stock market. This is what happens during an initial public offering (“IPO”). If an existing public company wants to raise money it may do so through a secondary public offering. In both cases, after the stock is issued, it can be bought or sold by the public (see those first two bullets above).
Stocks aren’t the only thing that can be bought or sold on a stock market. Other “securities”, such as exchange-traded funds (ETFs) or REITs are also traded on the stock market (some details about how they’re priced or traded differ though).
Are there risks to the stock market?
Yes. If you invest in the stock market, it’s important to keep in mind both the short-term and long-term risks. Just as stock prices can rise, they can also fall. Sometimes by a lot. The price of a stock can drop to $0, and this may result in the total loss of an investment. Given this risk, investors should have a thoughtful strategy in place to help guide their decisions.
When people say “the stock market rose,” what do they mean?
Stocks from thousands of companies are traded on stock markets. To understand what happened to stocks in general at any given time, you’ll notice that people often look at stock market indexes, such as the “Dow Jones Industrial Average” or the “S&P 500 Index.” The S&P 500 is a weighted average of 500 of the largest publicly traded companies listed in the US by their market capitalization value. When the S&P 500 increases, you might hear investors say that “the stock market rose.” When the S&P 500 decreases, you’ll instead hear investors say “the stock market fell.”
How does the stock market work?
The primary role of the stock market is to bring buyers and sellers together to negotiate the trade of stocks. To determine the price, a stock market operates kind of like an auction.
- Buyers want to pay the lowest price possible. Stockbrokers who want to buy (or who represent customers who want to buy) can bid a price they’re willing to pay for a stock. The highest price becomes the “Best Bid.”
- Sellers want to sell at the highest price. Owners of stock or their stockbrokers can show their willingness to sell by placing an ask, which is the price they’re willing to sell a stock for. The lowest price becomes the “Best Ask.”
The difference between the Best Bid and Best Ask is called the “Spread.” The two sides negotiate to meet in the middle, and the intermediary who executes the trade takes the difference as their fee.
As you follow a stock, you’ll notice the share price moves. The share price can change frequently based on the number of investors looking to buy or sell the stock and the number of trades that happen.
Stocks are traded on an individual basis through the negotiation between the bid and ask prices. Those prices can move together with stocks of other companies as economic, political, and specific news stories affect the movement of markets in general.
Who uses the stock market?
Here are some of the key players you should know about:
- Retail investors like you can buy or sell individual stocks through your brokerage account. When you place an order, it’s sent to exchanges where the trades are executed.
- Stockbrokers are “registered representatives” who have gone through training and passed a licensing exam. They can buy and sell securities on behalf of investors. Stockbrokers work for brokerages, which can act as principals or agents in transactions, making money through markups/markdowns (as principals) or commissions (as agents) on trades. Many brokerages charge fees to their customers who use the brokerage to place orders and execute the trade of a stock.
- Portfolio managers act like restaurant owners — they’ll order a ton of food because they’re feeding plenty of people. Portfolio managers make large orders to buy and sell stocks because they manage relatively large stock portfolios, which can be owned by other investors like you. If you own shares in a fund (a mutual fund, retirement fund, pension fund, etc) a portfolio manager likely handles the bundle of underlying securities (stocks, bonds etc.) in the fund’s portfolio.
- Investment bankers help companies list shares on stock exchanges.
Who are the participants in the stock market?
Investors are the driving force of the stock market — they’re the ones who want to buy or sell stock. But between those buyers and sellers are important actors who earn money by providing a service to investors. Here are some key ones:
- Principals: This is a broker-dealer firm that owns a portfolio of shares that they are willing to sell to investors. It’s also willing to buy stock from investors who are trying to sell. Broker-dealers acting as principals make money by adding a markup to stocks they sell and a markdown to stocks they buy, kind of like how a car dealer would mark up the price of cars sold to its customers.
- Agents: They’re in the middle. An agent helps connect one investor’s buy or sell request with the other side of the transaction. For that matchmaking service, they often take a commission.
- The stock exchange: The New York Stock Exchange and Nasdaq are the two best-known stock exchanges in the US, but there are actually 13 total. They take a small fee for each transaction that happens on their exchange in return for their services. They also charge a listing fee to the companies that offer their shares on the exchange.
- Custodians: They hold your stocks for you — mostly in electronic form so there’s less risk of loss, theft, or misplacement. Brokerage houses often pay custodians for this safekeeping service.
- Market Makers: Market makers are like your buddy who’s up for anything. They’re firms that stand by, ready to buy or sell a stock at publicly quoted prices.
- Retail Investors: Retail investors are individuals, not professionals. They may buy or sell stocks (or other assets) through their personal brokerage accounts.
Who regulates stock markets?
With great power comes great responsibility. Stock markets handle trillions of dollars in wealth, so Congress has granted the authority to regulate stock markets to the US Securities and Exchange Commission (SEC). Other countries (and states) have similar regulatory and enforcement agencies. These regulators have a broad mandate, and it’s focused on customers like you:
- Protect the investing public
- Promote fairness
- Maintain efficient markets
What are some rules of the stock market?
The SEC sets rules and requirements that affect everyone participating in stock trading. While these rules can differ in specifics for different stock markets in different countries, they’re intended to protect the investing public through transparency, consistency, and accuracy.
- Price transparency: Stock markets should ensure that the best “bid” (the price a buyer wants to pay) and the best “ask” (the price at which a seller wants to sell) are displayed to participants to maintain fairness.
- Confirmations: If you’re a brokerage customer trading shares on the stock market, you’re entitled to a trade confirmation showing the key details of the trade. These can include the time the trade was made, the final price you paid, and (if your broker charges a fee) the specific commission or markup/markdown you were charged.
- Qualification exams: Stock traders are licensed by FINRA, a self-regulatory organization whose members are exchanges and financial institutions. The licensing process involves taking some serious exams that cover how markets work, among other things. The Series 7 exam, for instance, is given to help ensure the brokerage professionals are sufficiently prepared and knowledgeable on general financial industry rules.
- Halts: If trading in a stock or the entire market meets specific price or volatility limits within a certain amount of time, the exchange may halt trading temporarily or for a full day. It’s a rare, but serious move to help protect investors from panicked trading and help restore order. There may be other important reasons for the SEC or exchange to halt trading.
- Major News Updates: Stock markets may also halt trading in a stock when significant breaking news is to be introduced, allowing investors more fair access to trade based on the publicly distributed information, like a big acquisition or a bankruptcy filing. This prevents certain investors from having an unfair information advantage.
These are some of the many detailed rules designed to make stock markets more transparent, consistent, and accurate for investors. The investor protection rules from regulators and self-regulatory organizations aim to provide a stable foundation for stock markets to more properly function and help gain the trust of customers.
A key feature of modern stock markets is the presence of real-time data concerning prices. Since investment decisions should be based on the most up-to-date information, stock exchanges are increasingly focused on faster and more accurate pricing information.
What are some examples of stock markets?
The world’s two largest stock markets based on their value by market capitalization are in the US: The New York Stock Exchange and Nasdaq. A variety of other prominent stock exchanges exist worldwide, including the Euronext (with marketplaces in Amsterdam, Brussels, Dublin, Lisbon, and Paris), Bombay Stock Exchange in Mumbai, TMX Group in Toronto, Deutsche Boerse in Frankfurt, the Shenzhen Stock Exchange, and the Shanghai Stock Exchange. These stock markets are exchanges where companies within a specific region tend to list their shares. These regional markets can also be accessed by traders globally, and stocks listed on one exchange can sometimes trade on exchanges in other regions too.
What is the origin of the stock market?
Stock markets exist across the world, connecting buyers and sellers of shares in various companies. The concept of a company dividing up ownership (also known as “equity”) of itself to be distributed to investors and traded dates back hundreds of years. During the 1600s, European explorers would raise money by selling shares in their company’s ventures. Investors would purchase stock to gain the profits of explorers’ missions, like the company’s pursuit of foreign spices to be brought back and sold in Europe. The Dutch East India Company was among the first to do this, offering shares of itself in exchange for future profits on Amsterdam’s stock market. The trading of these shares formed some of the first stock markets.
What is the history of the modern stock market?
The first modern stock market was in London. The combination of a lack of regulatory oversight, growing consumer enthusiasm for stocks, and minimal publicly available information on companies resulted in significant volatility, risk, and potential for fraud. Those forces lead to the formation of the London Stock Exchange in 1773 to provide a haven for more consistent and fairer trading of stocks.
In the United States, the first modern stock exchange was founded in Philadelphia in 1790. Two years later, the New York Stock Exchange (NYSE) was established as a result of the Buttonwood Agreement, signed by 24 stock-dealers outside of Wall Street in Manhattan (under a buttonwood tree). Today, the NYSE features a combination of electronic trading and a physical trading floor with human traders located on Wall Street. The NYSE trading floor is now a National Historic Landmark. It’s known for the loud bell rung every morning (at 9:30 am local time) and afternoon (at 4:00 pm) to mark the start and close of the trading day.
In 1971, Nasdaq (National Association of Securities Dealers Automated Quotations) began trading as the world’s first electronic stock market. Embracing technology, Nasdaq also became the first stock market in the US to trade online. Unlike the NYSE, it doesn’t have a central trading floor with human traders. Nasdaq is now a popular venue for tech companies to list their shares.
The NYSE (in downtown Manhattan in New York) and Nasdaq (in midtown Manhattan) are not only the two largest stock markets in the world based on the value of the shares traded on them — they’re also fierce crosstown rivals competing for companies that are choosing where to list their shares for an IPO. Whether a company gives its rose to NYSE or Nasdaq has little impact on you as a stock buyer or seller. Retail investors are generally able to purchase stocks through their brokerage account regardless of what exchange they’re listed on.
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