What are “Stock Exchanges”?
A stock exchange acts as a market where stockbrokers and traders can buy and sell securities, mostly shares in listed companies but also bonds and other financial instruments, including certain derivatives. Only securities specifically listed on a particular stock exchange can be traded there. In addition, stock exchanges can offer facilities for the issue and redemption of such securities. Traditionally, stock exchanges function as “continuous auction” market with buyers and sellers consummating transactions via open outcry at a central location, such as the floor of the exchange. Nowadays, these exchanges exist mostly as electronic marketplaces using a fully automated, electronic trading platform. Prices are set by supply and demand in the market.
Key Learning Points
- Stock exchanges connect the buyers with the sellers and offer a centralized location that brings corporations and governments (sell-side) together with investors (buy-side).
- The trading of buying and selling these securities can be done through stock brokers and traders.
- Auction-based exchanges, such as the New York Stock Exchange, allow traders and brokers to physically and verbally communicate buy and sell orders.
- Most modern exchanges use electronic trading platforms.
- Different type of securities are traded on a stock exchange, including stock issued by listed companies, bonds, derivatives, as well as pooled investment products.
- Exchanges are typically heavily regulated, provide liquidity in the market, and enable the trading of securities in an orderly and fair manner.
- In recent years, shadow trading on alternative trading venues, including “dark pools”, have taken away significant activity from traditional stock exchanges.
- The difference between the stock’s bid price and the asking price is the bid-ask spread.
Stock Exchanges Explained
Key Roles and Regulation
Essentially, stock exchanges bring corporations and governments together with investors. In addition, exchanges help provide liquidity in the market by attracting enough buyers and sellers so that trades can be processed efficiently without delays. Exchanges also ensure that trading occurs in an orderly and fair manner, so important financial information can be transmitted to investors and financial professionals.
To be able to trade a security on a certain stock exchange, the security must be listed on that exchange. Every stock exchange is subject to the regulatory requirements of the country where the stock exchange is located. These requirements can differ from country to country but the listing requirements can also differ significantly between different exchanges in the same country. For example, the listing requirements of the London Stock Exchange (LSE) are different from the London based Alternative Investment Market (AIM). Usually, there is a central location, at least for record keeping, but trade is increasingly less linked to a physical place, as modern markets use electronic communication networks which give them advantages of increased speed and reduced cost of transactions.
Trade on an exchange is restricted to brokers who are members of the exchange. In recent years, various other trading venues, such as electronic communication networks, alternative trading systems, and “dark pools” have taken much of the trading activity away from traditional stock exchanges, which has led to industry wide consolidation. Leading exchanges have become more open for listing foreign companies so that some stock exchanges now have more foreign than domestic companies on their exchange.
Stock Exchange Mechanics / Bid-Ask Spread
Stocks first become available to trade on an exchange after a company conducts its initial public offering (IPO). This is when a company offers to sell a portion of its shares to an initial set of public shareholders. This IPO is known as the primary market. The general public can then participate in trading those stocks on the secondary market after a company’s initial public offering.
The exchange tracks the flow of orders for each stock, and it is the flow of supply and demand that establishes the price of a stock (share). Depending on the type of brokerage account, one may even be able to view this flow of price action. For example, if a stock’s bid price is $40, this means an investor is telling the exchange that they are willing to buy the stock for $40. At the same time, one may see an asking price of $41, meaning somebody else is willing to sell the stock for $41. The difference between the two is the bid-ask spread. Traders on a stock exchange usually quote the bid-ask spread and the wider the spread, the more opportunity there is to make money from trading the stock.
Calculating International Stocks on an Exchange
Quite often, stock markets can trade listed companies that have international operations rather than purely domestic businesses. Also, companies can choose (within the rules set by exchanges) which market and country they would like to be listed on. A company may have a preference for a market where most of its peer group or sector trades (such as technology stocks). Whichever exchange they list on, they MUST abide by that set of rules which may also include restrictions on where the headquarters need to be based etc.
From the list below, please calculate the ratio of foreign versus domestic companies for some of the Stock Exchanges in the world (2018). Kindly select the most international stock exchange by % foreign companies / total listed companies.
The table below shows the calculated percentages of foreign companies on each of the listed exchanges. 36% of companies listed on the Singapore Stock Exchange are foreign companies.
Stock exchanges are important marketplaces for financial markets as a range of financial instruments, including equities, commodities and bonds, but also certain derivatives, are traded there. Whilst stock exchanges ensure that trading takes place in an orderly and fair manner, so called “dark pools” have taken trading away from traditional stock exchanges to alternative trading places. The largest stock exchange by Market Cap is the New York Stock Exchange, closely followed by NASDAQ. The largest stock exchanges outside of the US are the Shanghai and Tokyo Stock Exchanges. Many stock exchanges have an increasing number of foreign companies listing on their exchange, mostly for investor liquidity and/or tax reasons.