A stock exchange is a marketplace or platform that allows traders to buy and sell shares of publicly listed companies. It is usually centralized, thus reducing counterparty risks that are present in transactions that take place only between two parties.
According to the stock exchange definition, exchanges can trade stocks, commodities, bonds, and exchange-traded products (ETPs), amongst other assets. They also have strict regulations for both companies who want to register with them, as well as traders or investors.
Key Takeaways
- Exchanges are where the majority of securities transactions take place.
- Companies listed on stock exchanges are required to follow strict financial regulations and compliance guidelines.
- While in-person stock exchanges were common in the past, almost all exchange transactions now happen digitally.
- Various stakeholders – brokers, cleaning houses, and regulators – have their own roles within the stock market ecosystem.
- Stocks can be volatile investments with wild price swings depending on the market and company.
How Stock Exchange Works
Stock exchanges can usually be divided into two markets, primary and secondary.
The primary market is for newly-listed companies issuing shares and bonds for the first time. These can be in the form of initial public offerings (IPOs), preferred allotment, private placement, or a rights issue, amongst others.
This gives investors an opportunity to buy securities straight from the issuer, sometimes at a discounted price. Companies also use this as an opportunity to raise funds or increase their credibility and visibility.
Following the initial issue, the secondary market is where the bulk of stock and securities trading is done. This is usually between the investors themselves rather than between the issuer and the investor.
Investors can range in size from giant institutional investors and financial corporations to retail investors and individuals. The secondary market is what is most commonly recognized or associated with stock exchanges.
Compliance Measures
Listed corporations often face various compliance measures. Among these is the necessity to uphold a minimum stock price consistently throughout the year.
Additional requirements can depend on the regulatory authorities within a given country. These typically encompass financial obligations, adherence to regulations, and benchmarks related to the company’s reputation and performance.
Stock exchanges provide a variety of financial information, such as:
- Dividend yield
- Net income
- Revenue
- Market capitalization
- Profit margin
- Price/earnings ratio (P/E ratio)
- Earnings estimates
- Debt
- Trading volumes
Key Roles at a Stock Exchange
There are a variety of different entities that play a role in the stock exchange ecosystem, creating a seamless exchange system that benefits users.
Market Maker: Entities that provide liquidity to the exchange
Broker: Intermediaries to execute trades on behalf of clients
Trader: Entities that place exchange orders
Clearing House: Financial firms that clear and settle trades
Regulator: Organization (usually governmental) that oversees and regulates exchanges
Technology/Data Providers: Firms supplying exchange technology and data solutions
Market Maker: Posting bid-ask prices, ensuring liquidity, reducing market volatility
Broker: Facilitating trades, offering investment advice
Trader: Executing trades, analyzing market conditions, managing portfolio risk
Clearing House: Mitigating counterparty risk, ensuring timely settlement
Regulator: Enforcing financial laws and regulations, Protecting market integrity and investors
Technology/Data Providers: Providing market data, Ensuring top-notch cybersecurity, enhancing market transparency
Market Maker: Financial institutions
Broker: Fidelity, Vanguard, JPMorgan
Trader: Retail investors, hedge funds
Clearing House: DTCC, Euroclear
Regulator: SEC, FCA
Technology/Data Providers: Bloomberg, Reuters, Nasdaq Technology
Purpose of a Stock Exchange
Stock exchanges were originally created to help facilitate transactions for stocks, bonds, and other securities. Before the creation of exchanges, people traded stocks directly with one another in places like the town square, coffeehouse, or through bulletin boards. But these methods of direct trading were very inefficient.
Exchanges came along to match buyers with sellers in financial markets, providing liquidity for businesses and individuals, greater investment opportunities, and a regulated market on which financial transactions could be conducted.
Types of Stock Exchanges
Stock exchanges may appear in a variety of types, as highlighted below.
Stock Exchanges vs. OTC Markets
| Aspect | Stock Exchanges | OTC Markets |
| Trading Venue | Established exchanges | Broker-dealer network |
| Securities Traded | Bonds, stocks, derivatives, etc. | Bonds, stocks, derivatives, etc. |
| Listing Requirements | Stringent, typically for larger companies | Less stringent, often for smaller companies |
| Regulations | More regulated | Fewer regulations but not completely exempt |
| Company Size | Usually, bigger companies listed | Often, smaller companies listed |
| Reason for Listing | Companies meeting set criteria | When a company fails to continue maintaining its annual or other regulatory requirements, an exchange may demote it to OTC |
| Investor Access | Limited to bigger, established companies | Access to shares of companies that may not be on other exchanges |
| Stock Type | Mostly established, stable stocks | Includes low-cost penny stocks, potentially risky |
| Trade Volume | Generally high | Can be low, leading to liquidity issues |
| Safety Concerns | More regulated, generally safer | Riskier due to the potential inclusion of unstable firms |
Alternative Trading Systems
There are alternatives to traditional stock exchanges that allow individuals to trade securities or other financial assets.
These alternative trading systems (ATS) include:
Global Exchanges
Global stock exchanges help facilitate financial transactions across borders and increase liquidity for financial instruments. This is similar to localized exchanges but on a much grander scale that allows for more foreign capital investment and opportunity for both issuing companies and investors.
Using digital technology, global exchanges are able to facilitate near-instant trades from investors around the globe, unlocking new opportunities for financial markets. This can help foster economic growth, instill investor confidence, contribute to financial stability, and promote global connectivity.
Stock Exchange Examples
There are several well-known stock exchanges across the world today, such as:
- New York Stock Exchange (NYSE)
- London Stock Exchange (LSE)
- Shanghai Stock Exchange
- S&P 500
- NASDAQ
Out of these, the New York Stock Exchange and NASDAQ are the biggest, with a market capitalization of $28.4 trillion and $25.4 trillion, respectively, as of March 2024.
The NASDAQ index mostly contains tech giants such as Apple, Meta, and Alphabet. The S&P 500, on the other hand, is considered a gauge of the US stock market’s performance.
Stock Exchange Pros and Cons
Pros
- Ease of buying and selling
- Organized and regulated
- Diversity of Investments
- Transparency
Cons:
- Volatility
- Skewed markets
- Variety of fees
The Bottom Line
Stock exchange meaning refers to a marketplace where you will likely do most of your securities transactions.
Exchanges provide a level of transparency and liquidity to the market, thereby making trading quite easy. Plus, strict financial regulations mean that exchanges are quite safe and secure.
However, don’t forget that stocks can be volatile, and you may pay fees for trading on exchanges, which could affect your potential profits.
