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What is the Stock Market?

Jack and Nick Author Pic
Jack Kramer & Nick MartellAugust 26, 2019
Forbes 30 Under 30 in media, appeared on CBS, Cheddar. Registered representatives of Robinhood Financial LLC.
definition

Stock markets are where buyers and sellers of stocks come together to trade shares in companies.

🤔 Understanding the stock market

Stocks are bought and sold on stock markets, which bring together buyers and sellers of publicly traded company shares. Stock markets operate kind of like auctions, where potential buyers name their highest price (“the bid”) and potential sellers name their lowest price (“the ask”). The actual price a trade is executed at is somewhere between the bid and the ask. Trades can be placed by stockbrokers, usually on behalf of portfolio managers or individual investors like you. The stock market in the US is made up of 13 exchanges, the best known are the New York Stock Exchange and Nasdaq.

example

Snapchat-owner Snap Inc. listed its shares publicly on the stock market with its 2016 IPO. Its shares now trade on the New York Stock Exchange with the ticker symbol “SNAP,” and they’re available to buy and sell on the stock market by everyday investors like you.

Takeaway

The world’s stock markets are complex, but are all based upon one simple concept...

Connecting stock buyers with stock sellers to trade under an agreed upon set of rules. This is the key role of every stock market, from New York to Hong Kong.

Tell me more...

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 are the stock market participants?
How do you invest in the stock market?
Who makes money 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 in a stock market:

  • Stock buying: Both everyday retail investors and sophisticated institutional ones can purchase shares of companies.
  • Stock selling: Every time a stock is bought, someone had to sell it. Stock selling and stock buying are different sides of the same transaction.
  • Issuance of stocks: If a company wants to raise new money, it can create new shares of itself to sell on the stock market. This is what happens during an initial public offering (an “IPO”) or a secondary public offering. After a stock is issued, it can be bought or sold freely (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 or mutual funds, 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. After you choose a strategy and then invest in the stock market, it’s critical 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 on the stock market, losing all the money you invested. Given this risk, investors should have a thoughtful strategy in place before investing to 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 people often look at the stock market indexes, such as the “Dow Jones Industrial Average” or the “S&P 500.” 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’ll hear investors generally 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. 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 are the stock market participants?

Here are some of the key players on the stock market you should get to know:

  • 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 (like Robinhood Financial LLC), 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 these fees to their customers who use the brokerage to place orders and execute the trade of a stock.
  • Portfolio managers act similarly to an owner of a restaurant — 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 funds, which can be owned by other investors like you. If you own shares in any type of fund (a mutual fund, retirement fund, pension fund, etc) a portfolio manager handles the bundle of the underlying stocks in the stock fund’s portfolio.
  • Investment bankers help companies list shares on stock exchanges and they get paid for doing it.

How do you invest in the stock market?

Individual investors like you can buy and sell stocks through brokerage accounts. Some of the largest brokerage companies by amount of customer assets as of Q1 2019 are Fidelity Investments, Charles Schwab, Wells Fargo, and TD Ameritrade. Robinhood Financial LLC is also a brokerage company. Your brokerage company is required by law to trade for you at the best price available and to clearly show you the commissions or markup/markdown they’re charging.

Who makes money 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 stock buyers and sellers are intermediaries, and they earn money by providing a service to investors. Here are the 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.

Retail investors like you typically pay commissions or markup/markdowns when dealing with most stockbrokers or broker-dealer firms. If those fees are charged to you, the customer, they must be clearly stated on a trade confirmation. And when you opened your brokerage account, they should be clearly communicated to you, too. Retail investors also indirectly pay stock exchange listing fees and custodial fees, but those are sometimes baked into the commission or markup/markdown.

Who regulates stock markets?

With great power comes great responsibility. Stock markets are where people can invest their paychecks, their savings, their inheritance, or just their lunch money. So Congress has granted the authority to regulate stock markets in the US to the Securities and Exchange Commission (SEC). Other countries have similar regulatory and enforcement agencies, and the US has similar state-level regulation. 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 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 legendary Series 7 exam, for instance, is given to help ensure the professionals running stock markets are sufficiently prepared and knowledgeable on general financial industry rules.
  • Halts: If trading in a stock or the entire market plummets within a certain amount of time, the exchange may halt its trading temporarily or for a full day. It’s a rare, but serious move to help protect investors from panicked selling. There may be other important reasons the SEC or exchange may halt trading, too.
  • 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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