How Stock Exchanges Work

A stock exchange is a marketplace where investors can meet to trade stocks and exchange-traded funds (ETFs). While the New York Stock Exchange (NYSE) and the Nasdaq are household names, there are other types of exchanges that investors can use to buy and sell investments. Here’s what you need to know.

A stock exchange is hosted by an institution. For example, the Nasdaq is owned by Nasdaq Inc., while the NYSE is operated by Intercontinental Exchange. Together with the U.S. Securities and Exchange Commission (SEC), these organizations design rules to determine which companies can list their stock on the exchange to be traded by investors.

To be listed, a company must first make an initial public offering to institutional investors, such as investment banks. Afterward, those shares will become available to individual investors on stock exchanges via brokers. Other requirements for companies to be listed include a minimum stock price, minimum market capitalization, and transparent financial reporting.

Stocks can be traded on more than one exchange at a time. In addition to the NYSE and Nasdaq, a few other stock exchanges operate in the U.S., including the Philadelphia Stock Exchange, the Boston Stock Exchange, and the NYSE Arca. Other countries have their own stock exchanges.

Stock Exchange Players

While you can buy and sell stocks and ETFs on a stock exchange, you generally can’t do so directly. Here are the four groups of institutions and individuals who participate in an exchange:

• Brokers: Individuals and firms that buy and sell stocks and ETFs on behalf of other investors like you.
• Dealers: Individuals and firms that buy and sell stocks and ETFs for themselves.
• Broker-dealers: Individuals and firms that buy and sell stocks and ETFs on behalf of other investors and for themselves. Most brokerage firms act as broker-dealers.
• Market makers: Individuals and firms that act as intermediaries, buying and selling stocks and ETFs to bridge the gap when buyers and sellers don’t connect immediately. In other words, they help maintain liquidity in the exchange.

Types of Stock Exchanges

In addition to traditional stock exchanges, there are other types of markets where you can buy and sell stocks and other securities. Even among traditional exchanges, there are some differences. Here’s a quick summary of the different options:

Auction Markets

An auction market involves buyers and sellers making a trade based on the highest price the buyer is willing to pay and the lowest price the seller is willing to accept. As a result, there are no direct negotiations between buyers and sellers. The NYSE is an example of an auction market.

Dealer Markets

In a dealer market, such as the Nasdaq, dealers post prices at which they’ll buy and sell a certain stock, acting as a market maker. In other words, individual investors buy and sell stocks through dealers rather than between each other. Bonds, foreign currency, and derivatives may also be traded on dealer markets.

Alternative Trading Systems

Alternative trading systems (ATS) function similarly to exchanges, but they don’t have the same regulatory standards. An ATS can trade both listed stocks and unlisted stocks—examples include penny stocks, bonds, and other over-the-counter securities. Stocks and other securities traded through an ATS may not have the same level of financial transparency as stocks and ETFs traded on traditional exchanges.

How to Buy Stocks on a Stock Exchange

While some stock exchanges operate from a physical location—the NYSE has a trading floor in New York City, for instance—you can’t just walk in and buy a stock you have your eye on. Instead, you’ll need to work through a stockbroker, which can be an individual or brokerage firm. As a member of an exchange, a stockbroker can act as an intermediary between you and other investors, dealers, and market makers.

You’ll determine how many shares of a stock or ETF you want to buy or sell based on the current price. Then, the broker will facilitate the trade on your behalf. The most common types of stockbrokers include:

• Direct market access brokers: These brokers provide you with direct access to the exchange, leading to faster transactions. This option is best for active traders who do their own research, but it’s more expensive than discount brokers.
• Discount brokers: These brokers work to give you the cheapest transaction possible, generally with no commission. Discount brokers, which include online brokers, are best for investors who want to perform research and trade on their own to minimize costs.
• Full-service brokers: These brokers provide a holistic approach to your investment plan, providing educational resources, personalized investment advice, and other financial planning services. In many cases, you can offload the work of managing your portfolio to an advisor. Because they do a lot of the legwork, full-service brokers typically cost the most.

Frequently Asked Questions

What Are the Major Stock Exchanges?

The major stock exchanges include the New York Stock Exchange (NYSE), Nasdaq, and other regional exchanges like the Philadelphia Stock Exchange and the Boston Stock Exchange.

What Is the Difference Between Stock Exchange and Stock Market?

A stock exchange is a specific marketplace where stocks are bought and sold, while the stock market refers to the overall network of exchanges and other venues where stocks are traded.

How Do Stock Exchanges Make Money?

Stock exchanges make money through listing fees charged to companies, transaction fees for trades, and other services provided to market participants.

The Bottom Line

A stock exchange acts as a network where buyers and sellers of stocks, ETFs, and other securities can meet to make trades. But while the inner workings of stock exchanges can be complex, buying and selling stocks can be as simple as talking to your financial advisor or submitting a stock order through your online brokerage account.

Regardless of how you approach your investment portfolio, it’s important to take time to develop an investment strategy based on your current situation and your financial goals, then create a diversified portfolio based on that strategy.