Financial Literacy

Introduction to the Stock Exchange

Learning the basics of what a stock exchange is and how it operates, requires understanding the benefits and functions, the players involved in the process, the terminology used, and how trading works. The largest exchange in the United States, the New York Stock Exchange (NYSE), is a good example to scrutinize to familiarize the beginning investor or just the curious learner with the fundamentals of securities markets. [1, 2, 3]

New York Stock Exchange

The New York Stock Exchange traces its roots to 1792, when in May of that year twenty-four brokers signed a pact, known as the famous Buttonwood Agreement. This agreement was the beginning of a limited stock exchange, whereby the members agreed upon trading rules and exclusivity, in other words, trade only amongst themselves.

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Today, the exchange provides a centralized market, a place for businesses to raise capital by issuing new securities, as well as a place for buyers and sellers to come together to make trades. The rules of trading established by the exchange seek to promote fair trading and provide a place for investors to gather. [1, 2, 3 ]

Deep Markets

Securities exchanges provide what economists call "deep markets" that can handle a huge volume of trading and provide investors with liquidity, a means to convert securities to cash quickly and easily. Due to the large volume of securities traded on a centralized exchange, such as the NYSE, transaction costs are lowered and sellers do not have to search for buyers outside of the exchange. Furthermore, the large volume of trading quickly incorporates economic news from around the world into stock prices, reducing volatility. [2, 3]

Dealers and Brokers

Dealers, or specialists in one or a few stocks, play a vital role in the function of an efficient stock exchange. A specialist in a particular stock promotes equitable share prices by buying or selling an assigned stock when the normal process of supply and demand cannot fulfill the needs of investors. Dealers take ownership of shares when necessary to facilitate the smooth operation of the exchange. Brokers mainly represent the interests of investors. Brokers do not take ownership of shares, but instead work as agents for investors. In other words, brokers are the go-betweens for buyers and sellers. [1, 2, 3]

Orders

When an investor makes a decision to buy or sell securities, she may contact her broker to place an order. The majority of orders placed at a centralized exchange are simple market orders, meaning the investor places an order to buy or sell a certain number of shares of a particular stock at the current market price. Instructions from the investor are forwarded to the specialist in that particular stock and the dealer then attempts to match a buyer with a seller. During days of heavy volume, millions of shares are traded smoothly in a well-run stock exchange. [1, 2, 3]
Exterior of the New York Stock Exchange
Exterior of the New York Stock Exchange

References

  • 1. Finance: Investments, Institutions, Management; Stanley G. Eakins; Pearson Addison-Wesley, Boston, Massachusetts; 2005.
  • 2. Investment Analysis and Portfolio Management; Fifth Edition; Frank K. Reilly and Keith C. Brown; Dryden Press, Forth Worth, Texas; 1997.
  • 3. New York Stock Exchange: A Guide to the NYSE Marketplace

See also the History of the New York Stock Exchange from the University of Illinois.


Related Pages

Stocks: An Introduction
Sectors in the Stock Market
Bonds: An Introduction
Bonds: Economic Factors that Affect Earnings
Bond Issuers: Corporations, Municipalities, and the U.S. Government
Mutual Funds: An Introduction
Investing: The Power of Compounding and the Time Value of Money
Investing: The Importance of Diversification
Investing: Glossary

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