Exploring Stock Exchanges
Investors can buy and sell equities on a stock exchange, which is a centralized location where corporations and governments are connected. The New York Stock Exchange is an example of an auction-based exchange where traders and brokers can communicate, buy, and sell orders in person. On the other hand, electronic exchanges take place on digital platforms, eliminating the need for a physical location. Finally, electronic communication networks connect buyers and sellers directly, bypassing market makers.
Basics
Stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq, serve as dynamic marketplaces, facilitating the interaction between buyers and sellers of stocks. These exchanges, despite their prominent positions in the financial world, do not possess ownership of the shares being traded.
In stock trading, brokers play a pivotal role, acting as intermediaries for most transactions. However, it is crucial to comprehend the intricate interplay between these exchanges and the companies that enlist their shares for trading. Each exchange imposes distinct requirements meticulously crafted to safeguard the interests of investors.
Exploring Stock Exchanges
Stock exchanges serve as the epicenters of financial activity, where diverse financial instruments such as equities, commodities, and bonds are actively traded. These bustling hubs unite corporations, governments, and investors, ensuring market liquidity. This is a state where sufficient buyers and sellers converge to facilitate seamless and prompt transactions. Additionally, stock exchanges play a vital role in fostering a structured and equitable trading environment, enabling the efficient dissemination of crucial financial data to investors and financial experts.
The inception of stocks onto an exchange unfolds following a company's inaugural public offering (IPO). In the primary market, during this IPO phase, a company dispenses shares to an initial set of public stakeholders. Subsequently, these shares transition to the secondary market, where they can be openly bought and sold. Subsequent to a company's initial public offering, the general populace gains access to trade shares in the secondary market.
Within the exchange's intricate ecosystem, order flows for individual stocks are meticulously monitored, influencing a stock's valuation based on supply and demand dynamics. Depending on your brokerage account type, you may have visibility into this price action flow. For instance, a bid price of $40 signifies an investor's willingness to purchase the stock at that price, while an asking price of $41 indicates another party's readiness to sell it for $41. The disparity between these two figures represents the bid-ask spread.
Auction-Based Exchanges
Auction exchanges, commonly known as the auction market, are platforms where buyers and sellers concurrently submit competitive bids and offers. Within this arena, the prevailing stock price represents the highest amount a buyer is willing to invest in a security. In contrast, the lowest price signifies the threshold at which a seller will transact. Trades are then matched and executed upon pairing.
The auction market, also called the open outcry system, entails brokers and traders engaging in physical and verbal communication on trading floors or designated pits to buy and sell securities. While electronic systems have gradually superseded this method, some exchanges, including the New York Stock Exchange (NYSE), continue to employ the auction system. The NYSE Closing Auction, the concluding event of each trading day, serves as the mechanism for establishing the closing price for all involved stocks by convening buyers and sellers.
New York Stock Exchange (NYSE)
The New York Stock Exchange stands as the largest equities exchange globally. Intercontinental Exchange (ICE) became the parent company of the NYSE following its merger with the European exchange Euronext in 2007. Despite the transition of some functions to electronic trading platforms, the NYSE remains a prominent auction market, featuring designated market makers who physically engage in trading specific stocks.
These specialists concentrate on particular stocks, participating in the auction process. However, they face competitive pressure from electronic-only exchanges, which assert superior efficiency through faster trade execution and narrower bid-ask spreads achieved by eliminating human intermediaries.
Companies listed on the NYSE possess a strong reputation, as they must meet initial listing criteria and adhere to annual maintenance requirements, including maintaining a share price above $4 to continue trading on the exchange.
NYSE investors enjoy a series of essential safeguards, including the necessity for shareholder approval of equity incentive plans and the stipulation that most board members be independent, with the compensation committee and audit committee comprising solely independent directors, along with at least one member possessing relevant financial expertise.
Electronic Trading on Modern Exchanges
Electronic exchanges represent a paradigm shift in trading, devoid of physical traders and traditional trading floors. Instead, trading unfolds seamlessly on electronic platforms, eliminating the need for a centralized physical meeting place for buyers and sellers.
These modern exchanges are celebrated for their remarkable efficiency and rapid transaction speeds, conducting daily trade volumes reaching billions of dollars. Among the premier electronic businesses globally, the Nasdaq stands out.
The Nasdaq
Frequently referred to as a screen-based exchange, the Nasdaq relies on computer-based connectivity over telecommunications networks to unite buyers and sellers. Market makers, also recognized as dealers, maintain their stock inventories and are ready to engage in buying and selling activities on the Nasdaq. They are obligated to publicly disclose their bid and ask prices.
Similar to the NYSE, the Nasdaq imposes stringent listing and governance standards. One notable requirement is that a stock must uphold a minimum price of $4. Failure to meet these criteria could lead to delisting, and the affected stock may transition to an over-the-counter (OTC) market. For instance, the NYSE would initiate the delisting process if a security's price remained below $1.00 for a consecutive 30-day trading period.
Electronic Communication Networks (ECNs) in the Trading Landscape
Electronic Communication Networks (ECNs) represent a category within the Alternative Trading Systems (ATSs) sector. What sets ECNs apart is their unique ability to directly connect buyers and sellers, eliminating the need for intermediary market makers. Consider ECNs as an alternative avenue for trading stocks listed on the Nasdaq and other prominent exchanges, such as the NYSE and foreign counterparts.
In the realm of ECNs, many innovative and enterprising platforms exist, benefiting customers through intensified competition leading to reduced transaction expenses. While some ECNs cater to retail investors, the primary user base comprises institutional investors responsible for managing substantial investments for entities like pension funds.
Notable ECNs include Nasdaq's Interbank Network Electronic Transfer (INET) and Arca Options, overseen by the NYSE. Moreover, ECNs empower brokerage firms and traders worldwide to engage in trading activities beyond the regular trading hours of major exchanges.
Over-the-Counter Trading
The term "over-the-counter" (OTC) encompasses markets distinct from the organized exchanges previously discussed. OTC markets typically feature smaller companies, many transitioning here after being delisted. Two key OTC markets include:
Over-the-Counter Bulletin Board (OTCBB)
OTCBB served as an electronic network for market makers, often becoming the new home for companies removed from Nasdaq. Notably, OTCBB imposed no quantitative criteria or mandatory minimums for annual sales or assets for listing. However, it ceased operations in November 2021.
Pink Sheets
The Pink Sheets represent another OTC market where companies are not obligated to register with the Securities and Exchange Commission (SEC). Liquidity tends to be limited, and these entities are not required to submit quarterly 10Q reports.
OTC Market Dynamics
Investing in OTC stocks can carry added risks, a fact that concerns some individual investors. Nevertheless, it's worth noting that several robust companies actively trade in the OTC realm. Certain larger corporations have purposefully migrated to OTC markets to evade the administrative burden and expensive regulatory compliance associated with laws like the Sarbanes-Oxley Act. For those considering OTC investments, particularly in penny stocks, caution is advised, especially if one lacks experience in this segment, as penny stocks are predominantly traded over-the-counter.
Other Exchanges
Around the world, many exchanges serve various financial markets, encompassing stocks, bonds, and digital currencies.
Asia
The Tokyo Stock Exchange (TSE) boasts over 3,800 listed companies with a combined market capitalization exceeding $5.6 trillion. Mainland China hosts the Shanghai Stock Exchange (SSE), the nation's largest exchange trading stocks, bonds, and mutual funds. The Shenzhen Stock Exchange (SZSE) operates as China's second-largest independent stock exchange.
Europe
Euronext, formed from the mergers of the Amsterdam, Paris, and Brussels stock exchanges, reigns as Europe's largest stock exchange. Located in the United Kingdom, the London Stock Exchange (LSE) is Europe's second-largest exchange. Within LSE, the prominent Financial Times Stock Exchange (FTSE) 100 Share Index, or "Footsie," comprises the top 100 publicly traded blue-chip companies.
Digital Exchanges
In the United States, Coinbase is the premier cryptocurrency exchange, offering a sophisticated trading platform for retail investors and custodial services for institutions. While Bitcoin remains the most popular cryptocurrency, Coinbase facilitates the trading of others, including Ethereum and Litecoin. Coinbase holds licenses as a cryptocurrency exchange in 42 U.S. states. Globally, Binance reigns as the leading cryptocurrency exchange, boasting an average daily trading volume of $2 billion. Notably, Binance now supports USD deposits via SWIFT transfer.
San Francisco-based Kraken is a cryptocurrency exchange where investors can trade various digital currencies against multiple fiat currencies, including USD, EUR, CAD, and JPY. Kraken supports over a dozen virtual currencies, such as Bitcoin, Ethereum, EOS, and Monero. Like most crypto exchanges, investors must establish and fund a digital wallet linked to their trading account.
Conclusion
Stocks require an exchange for trading where buyers and sellers converge. In the United States, the prominent exchanges are the NYSE and Nasdaq, each imposing specific requirements and governance standards, mainly related to board independence, on their listed companies.
Yet, other valid exchanges exist. Although relatively recent, electronic communication networks (ECNs) are poised to gain a more substantial market share in the future. Furthermore, the OTC market appeals to seasoned investors seeking speculative opportunities, provided they possess the necessary expertise to conduct additional due diligence.