What is a stock exchange? Understanding the marketplace where shares are bought and sold

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Stock exchanges today are largely virtual as automated electronic trading becomes the norm.

  • A stock exchange is a central marketplace where stocks and other securities are traded, bought, and sold.
  • Exchanges can be either physical or electronic, but electronic exchanges are now the norm.
  • The main purpose of an exchange is to connect buyers and sellers, and to bring stability, transparency, and efficiency to the trading process.
  • Visit Business Insider’s Investing Reference library for more stories

A stock exchange is a place where shares of publicly traded companies are bought and sold in real-time, either physically or electronically.

When you think of buying stock, the first thing to understand is the stock market is actually made up of a network of exchanges. The leading stock exchanges in the US are the New York Stock Exchange (NYSE) and the Nasdaq.

It’s on these regulated exchanges where a lot of action takes place. Stock exchanges are a major part of the market, and understanding how they work can give you a better handle on the inner workings of the stock market at large.

What is a stock exchange?

A stock exchange is a marketplace where you buy stocks, bonds, and other securities. It provides a platform for companies to sell stocks, and for investors to trade those stocks between each other – all within a regulated space that aims to make everything as efficient and transparent as possible.

There are many stock exchanges around the world, each catering to different markets. The NYSE, for example, is one of many stock exchanges in the world, but it’s also the largest by market capitalization, which measures the total value of securities traded there.

Historically, stock exchanges were primarily physical spaces with men standing on a floor yelling buy and sell orders. These days, exchanges are largely virtual with computers matching buyers and sellers together. The Nasdaq, which began operations in 1971, is a prime example of an electronic exchange.

When a company is “listed” on an exchange, that means the company can be traded on it. Listing requirements vary by exchange, but include meeting minimum criteria, such as number of shareholders, earnings, and stock price.

In return for meeting these requirements, companies enjoy the prestige of being on a major stock exchange. Being listed on a popular exchange gives companies visibility within the global marketplace.

How does a stock exchange work?

To understand the basics of how a stock exchange works, it’s helpful to understand the concept of primary and secondary markets.

  • Primary market: In a primary market, companies sell new shares of stocks to the public for the first time, such as an initial public offering (IPO). One of the most important things to note is in a primary market, securities are purchased directly from the issuing company.
  • Secondary market: After the issuance of new securities, the secondary market is where investors buy and sell securities to each other. This is where exchanges come in. The NYSE and the Nasdaq are both secondary markets. Secondary markets are essentially what’s understood as the “stock market.”

While an IPO on the primary market allows private companies to raise large amounts of capital, subsequent trading on the secondary market informs the current value of the stock through supply and demand.

Broadly speaking, a stock exchange can work as either an auction market or a dealer market.

In an auction market, traders bid on the price of a security based on how much they believe in its success, or how badly they want a stake in that company. Typically, buyers strive to get the lowest price possible, so that they can sell for a profit later, while sellers aim to be appraised appropriately.

In a dealer market, multiple dealers, or “market makers,” post the prices at which they’re willing to buy and sell a security, and the differences between the posted bid and ask prices illustrate the cost to investors. Market makers use their own capital to engage in the process and work to provide liquidity, making it quicker and easier to trade.

Trading through a stock exchange tends to be safer than the over-the-counter (OTC) market, where transactions take place directly between two parties rather than being facilitated by an intermediary. Generally, the OTC market is less regulated than a stock exchange and features smaller, riskier companies, like penny stocks.

Functions of a stock exchange

Securities are among the most intensely regulated industries in the US, and the SEC is responsible for regulatory oversight and investor protection.

More broadly, the government agency ensures that listed companies do not partake in fraud by overseeing the registering of new securities and coordinating appropriate filings, like quarterly earnings reports, so that companies remain transparent to potential buyers.

Stock exchanges serve a few key functions to both investors, traders, and listed companies.

  • Transparent securities pricing: Exchanges must ensure that buyers and sellers have access to accurate, up-to-date pricing and order information to make informed investment decisions. They play a major role in providing fair and transparent securities pricing, while also matching buyers and sellers efficiently.
  • Liquidity: Stock exchanges help new companies raise capital while providing instant order access to investors. Exchanges promote market liquidity, allowing for the rapid exchange of stock without significantly affecting its price.
  • Secure transactions: Although being accessible to many market participants is a crucial piece of the puzzle, it’s also important that buyers and sellers are credible and appropriately verified. Stock exchanges ensure that participants meet necessary requirements and follow regulations as directed in order to reduce the risk of default.
  • Investor protection: Exchanges are accessible by both institutional and less experienced investors and must offer protections, like appropriately categorizing stocks by level of risk, to those with limited financial knowledge. This promotes consumer trust and protects less experienced investors from severe financial loss.

Important stock exchange participants

Stock exchanges have quite a few moving parts and everyone involved plays a specific and necessary role. Here’s a breakdown of who’s who:

  • Brokers: Brokers are professionals or firms that act as intermediaries between outside investors, who don’t have access to the inner workings of the exchange, and the market. Brokers represent their clients’ best interests, aiming to buy or sell at the price most beneficial to the investor, and are usually paid on a commission basis.
  • Dealers: Dealers are firms or individuals who execute trades for themselves, rather than for a client or third party, in an effort to maximize their own profits. Dealers make money by selling stocks at higher prices than they initially paid.
  • Market makers: Market makers are dealers who aim to increase the liquidity of the entire exchange, buying and selling a large-volume of stocks to ensure trades occur . This heightened liquidity benefits all parties involved by making trading more efficient.
  • Broker-dealers: As the name suggests, these individuals or firms are a combination of brokers and dealers, serving the interests of both themselves and their clients.

Major stock exchanges

There are many stock changes around the world. Here is a look at a few, along with their most current market cap.

Name Region Market Capitalization
New York Stock Exchange United States $25.6 trillion
NASDAQ United States $19.5 trillion
Shanghai Stock Exchange China $6.9 trillion
Euronext Stock Exchange Netherlands $6.8 trillion
Hong Kong Stock Exchange Hong Kong $6.1 trillion
Tokyo Stock Exchange Japan $5.6 trillion
Shenzhen Stock Exchange China $5 trillion
London Stock Exchange England $4.3 trillion
Toronto Stock Exchange Canada $2.9 trillion
Bombay Stock Exchange India $2.8 trillion

The financial takeaway

Stock exchanges are physical or electronic spaces where shares of publicly traded companies are bought and sold in real-time. These exchanges are highly regulated and generally safer than the OTC market, because regulations make companies less likely to default in paying investors back.

Exchanges simplify the process of finding buyers and provide these investors with peace of mind with regards to a company’s credibility since they regulate the companies listed on the exchange.

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What is the Nasdaq? Understanding the global stock exchange that’s home to the fastest-growing, most innovative companies

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The Nasdaq has a headquarters in New York City, though it’s actually an electronic stock exchange.

  • The Nasdaq is the world’s largest electronic stock exchange with two closely watched indexes: the Nasdaq Composite and the Nasdaq 100.
  • Technology, consumer services, and other growth stocks dominate Nasdaq and have caused it to outperform other stock markets in recent years. 
  • The easiest way for individual investors to participate in the Nasdaq’s volatile but high-performing stocks is via index funds.
  • Visit Business Insider’s Investing Reference library for more stories.

The Nasdaq is the largest and oldest electronic stock market in the world, meaning all of its buying and selling happens electronically, rather than on a physical trading floor. Short for National Association of Securities Dealers Automated Quotations, the Nasdaq is the second-largest stock exchange globally based on the market capitalization  of its listed companies – exceeded only by the New York Stock Exchange (NYSE). 

A pioneer in online operations when it launched in 1971, the Nasdaq provided a listing service for companies that had previously only traded over-the-counter (OTC). It quickly became the home for many new and innovative high-tech startups, including Microsoft and Apple.

Today, the Nasdaq plays an important role in the US and global economy, with its two major indexes – the Nasdaq Composite and the Nasdaq 100 – closely watched barometers of business.

To help you make sense of it all, here’s what you need to know about the Nasdaq, from what it is to smart strategies for investing. 

What is the Nasdaq?

The Nasdaq is technically a dealer market where both buyers and sellers trade with a market maker in a particular stock or security, unlike an auction market (like the NYSE) where buyers and sellers trade with each other through a broker.

Nasdaq fast facts

  • 3,889 listed companies trade on Nasdaq.
  • Nasdaq’s listed companies are collectively worth $11.23 trillion. 
  • Over 4.5 billion shares are traded daily on Nasdaq.
  • To be listed on Nasdaq, companies pay $47,000 to $163,000 in fees. 

Nasdaq’s 3,889 listed companies represent 10 broad sectors or industry groups. Most are in the fields of technology, consumer services, and health care. 

While Nasdaq has plenty of giant corporations, such as PepsiCo., PayPal, and Amazon, its stocks tend to be more growth-oriented, and less blue-chip, than those on the NYSE. Nasdaq equities have a reputation for innovation, disruption – and volatility

History of the Nasdaq

The Nasdaq was created in 1971 by the then-National Association of Securities Dealers (currently known as FINRA). Originally, it was just a quotation system – an electronic ticker of bid and ask prices – but it began adding trading and transactional systems.

  • In 2002, Nasdaq became a fully independent, publicly traded company. 
  • In 2006, it became an SEC-registered national securities exchange.
  • In 2007, it combined with the Scandinavian exchange group OMX to become the Nasdaq OMX group. 

The Nasdaq does not have, and has never had, a physical trading floor. This became a problem for the exchange in 1995 as major companies such as Microsoft threatened to leave. No trading floor meant no physical presence, no opening bell ceremony, and, more importantly, no place for media networks to broadcast from during the trading day. 

That problem was solved in 2000 with the construction of a massive 10-story tall tower at the corner of 43rd and Broadway in New York City, known as MarketSite, complete with video screens, a full television studio, and, yes, an opening bell ceremony. But the actual trading remains electronic.

It’s a bit ironic: Nasdaq, which began as an all-electronic exchange, had to create a physical presence to gain credibility with Wall Street. But eventually, the NYSE and other older, established exchanges, discovered the need for an electronic component in order to stay competitive in a rapidly evolving marketplace. 

The Nasdaq has two major indexes 

Nasdaq isn’t just a stock exchange. It also has two highly regarded indexes that track the performance of Nasdaq stocks daily: 

  • The Nasdaq Composite index tracks 2,790 Nasdaq securities – basically, everything but mutual funds, preferred stocks, and derivative securities. The Nasdaq is heavily weighted with technology stocks making it the ‘de facto’ bellwether for the tech sector.
  • The smaller Nasdaq 100 index focuses on the largest, non-financial companies listed on the Nasdaq. Over half of them are in the tech sector.   

Of the two, the Nasdaq Composite is the more influential. When commentators refer to “the Nasdaq closing up five points,” it’s usually the Composite they mean.

While the Composite index is more widely followed, the Nasdaq 100 is viewed by traders and investors interested in futures, options, and exchange-traded funds.

Calculating the Nasdaq indexes daily average

Both the Nasdaq Composite and Nasdaq 100 use the same modified market capitalization weighting method in which the closing price of each share (LSP) is multiplied by the total shares outstanding (TSO) for that company to arrive at that stock’s market capitalization.

Share weights are calculated by dividing each security’s market capitalization by the total capitalization of all index securities. Share weights for each stock are then multiplied by that stock’s closing price and the total divided by an index divisor that accounts for market fluctuations such as stock splits, mergers, and other actions. The result is the Nasdaq average for that day.

Performance of the Nasdaq indexes

Nasdaq stocks have led the charge of the long-running bull market the US has seen in the 2010s.  Its indexes have dramatically outperformed the S&P 500 (which tracks large-cap stocks), and the Dow Jones Industrial Index (the 30 largest US companies), two other stand-ins for the stock market overall. 

The explanation? Since both Nasdaq indexes lean heavily into tech, consumer services, and health care – all top-performing industries in recent years.

How to invest in Nasdaq stocks

You can always try to duplicate the Nasdaq 100 or the Nasdaq Composite yourself, with individual stock purchases. But it probably would be more efficient to invest in an index fund that tracks the market’s indexes. Many of them, naturally, trade on the Nasdaq. 

  • One of the most popular Nasdaq index funds is the Invesco Unit Investment Trust QQQ ETF (QQQ) which tracks the Nasdaq 100. 
  • To invest in the entire Nasdaq composite, Fidelity’s Nasdaq Composite Index ETF (ONEQ) is a popular exchange-traded fund. 
  • If you prefer a mutual fund, the Fidelity Nasdaq Composite Index Fund (FNCMX) is a well-established vehicle.

In addition to being a stock market, the Nasdaq is a public company and you can invest in it, too. It trades as Nasdaq Inc. (NDAQ). But remember, you are investing in the company itself – not in the stocks listed on its exchange.

The financial takeaway

The Nasdaq made history by being the first electronic stock market. Today, as the second-largest major stock exchange, the stock exchange reflects market movement in tech and high growth companies. The Nasdaq, and its indexes, are highly watched by those who invest in those types of securities.

Investing in the Nasdaq or Nasdaq stocks is, by definition, riskier and more volatile than investing in the NYSE or DJIA, both of which rely on more established, less volatile stocks. But that also means potentially higher returns. 

Weighted towards growth stocks, Nasdaq indexes have outperformed others. And investing in Nasdaq-tracking mutual funds or ETFs give investors an easy, efficient way to take advantage with less risk.

Related Coverage in Investing:

What is common stock? The most typical way to invest in a company and profit from its growth

What is the P/E ratio? An analytical tool that helps you decide if a stock is a good buy at its current price

A guide to stock market indexes: What they measure and how they can guide your investing

The price-to-book ratio is a way to determine if a company’s stock price accurately reflects its financial value

What is growth investing? A strategy that focuses on high-growth companies in hopes for significant investment returns

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