How Stocks Trade
Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You’ve probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other.
The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, thus reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer.
Really, a stock market is nothing more than a super-sophisticated farmers market linking buyers and sellers.
Before we go on, we should distinguish between the “primary” market and the “secondary” market. The primary market is where securities are created while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies.
The secondary market is what people are referring to when they talk about “the stock market.” It is important to understand that the trading of a company’s stock does not directly involve that company. To learn more about this, see our article entitled “Where Securities Are Traded.”
The New York Stock Exchange
The most prestigious exchange in the world is the New York Stock Exchange (NYSE). The NYSE is the first type of exchange, where much of the trading is done face-to-face on a trading floor. This is also referred to as a “listed” exchange. Orders come in through brokerage firms that are members of the exchange and flow down to floor brokers who go to a specific spot on the floor where the stock trades.
At this location, known as the stock trading post, there is a specific person known as the “specialist” whose job is to match buyers and sellers. Prices are determined using an auction method:
The current price is the highest amount any buyer is willing to pay and the lowest price at which someone is willing to sell. Once a trade has been made, the details are sent back to the brokerage firm, who then notifies the investor who placed the order. Although there is human contact in this process, don’t think that the NYSE is still in the Stone Age; computers do play a huge role in the process.
Filed under: Trading Articles