Stocks Basics: Understanding How Stocks Trade

Stocks are most often traded via exchanges or places where sellers and buyers convene to deliberate on prices. Most exchanges are actual physical buildings where such interactions take place on the trading floor. We have all seen pictures depicting trading floors in which the brokers and traders are gesturing wildly to each other; you may have even seen it on television or in movies. The other type of exchange market is one that is virtual, based in computer networks on which electronic trades are generated.

The function of a stock market is to expedite trades between sellers and buyers thus helping to eliminate the risks of trading. Can you picture how hard it would be to sell shares if you had to go through the phone book to try to find buyers? Basically, the stock market is glorified farmers market for investors and brokers.

It is important to understand the difference between the primary and secondary stock markets. The primary market is the market in which securities re generated through means of an IPO.The secondary market is where investors trade formally issued securities with no involvement on the part of the issuing companies. When people talk about the stock market is this market to which they are referring. It is crucial to keep in mind that when stocks are traded, the company is not directly involved in the investment.

The New York Stock Exchange

Obviously, the New York Stock Exchange (NYSE) is the most popular stock market worldwide. Otherwise known as the “Big Board”, the NYSE was founded in 1792 at the signing of the Buttonwood Agreement between a group of twenty-four NYC merchants and stockbrokers. Today, the NYSE is the preferred market for trading for some of America’s most popular companies include McDonald’s, Citigroup,Gillette, Walmart, General Electric and Coca-Cola.

The NYSE is the first type of exchanged market, which we discussed earlier. Most of the trading is done face-to-face on the stock floor. This type of exchange is known as a “listed exchange.” Orders come in via brokers firms that are belong to stock exchanged and are then handed down to the floor brokers who then go to the specific spot on the floor where that particular stock will be traded. This location, known as the trading post is where the “specialist” will be. Their job is specifically to match sellers and buyers. Prices are then determined via the auction method, which is the lowest price willing to be sold and the highest price a buyer is willing to pay for that particular investment. Once a trade has been conducted, the details are then sent back to the broker. The broker then will notify the investor who initially placed the order. Don’t be fooled however, this is not the Stone Age, even though human interaction takes place, computers are still involved in the trading process.

The Nasdaq

The other type of stock exchange is virtual and is often called the “over the counter” (OTC) market. The Nasdaq is the most popular OTC market. These markets do not have floor brokers nor a central location. All trading is done via computer and the dealers communicate via the internet. Until recently, it the most popular companies only dealt with the NYSE while the Nasdaq was reserved for second tier stock exchanges. However, the technical boom in the late 1990’s changed everything as Nasdaq is now home to quite a few major companies such as Cisco, Oracle, Del, Intel and even Microsoft. Nasdaq is now in competing with the New York Stock Exchange.

Nasdaq brokers are actually “market markers” for a variety of stocks. Basically this means they ask and bid prices for a certain percentage of shares. They are then designed to turn these into a market. They pair directly pair sellers and buyers while managing an inventory of their shares as they are required to meet the investor’s demands.

Other Exchanges

The American Stock Exchange (AMEX) is the next most popular exchange in the United States. It used to be the only alternative to the NYSE, until Nasdaq came along. In 1998, the parent company of Nasdaq, the National Association of Securities dealers (NASD) purchased AMEX. Now AMEX primary function is trade derivatives and small cap stocks.

There are quite a few stock exchanges worldwide. While the American markets are definitely the largest and most popular, they are just a fraction of the total investment markets around the world. The other two biggest markets are Hong Kong (Hong Kong Stock Exchange) and London (London Stock Exchange).

The final type of market is s the over the counter bulletin board or OTCBB. Although the Nasdaq is an OTC market, this term most often applies to smaller public companies that do not meet the requirements of regulated markets. The OTCBB is known for trading penny stocks as they require little to no regulation, however as there is no regulating authorities, trading in the OTCBB market can be extremely risky.