Understanding Stock Exchanges: A Comprehensive Guide

October 3, 2023
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Achieving success as an investor requires a solid grasp of stock market fundamentals, emphasizing the vital role of foundational knowledge. With a comprehensive understanding of stock exchange basics, like diverse stock types, market dynamics, and technical analysis, coupled with risk management techniques and securities, you can confidently navigate the world of stock investing.

What are stock exchanges

Stock exchanges are financial marketplaces where buyers and sellers come to trade various financial instruments, primarily stocks (also known as shares or equities), bonds, commodities, derivatives, and other securities. Among the features of stock exchanges are:

  • Organized market. Basically, the stock exchange is a marketplace. A regulated market provides a fair and transparent environment for trading.
  • Liquidity. Investors can easily buy and sell securities or convert their investments into cash if necessary on stock exchanges.
  • Price discovery. Thanks to the interaction between buyers and sellers, stock exchanges ensure price discovery, the process of determining the fair market value of a security.
  • Centralized location. Stock exchanges provide a centralized location for investors to trade securities. Thanks to it, it is easier for investors to find buyers and sellers for their equities.

Nowadays, traditional floor trading (traders physically gather on the trading floor of a stock exchange), which we saw in the movies, is a thing of the past. Now is an era of electronic trading. For example, over 99% of all trades are executed electronically in the United States.

Electronic exchange refers to the process of securities exchange such as stocks, bonds, derivatives, and IPOs (initial public offerings) using computerized systems and electronic networks.

How does the stock exchange work

Let us try and navigate the working process of a stock exchange on the example of one of the biggest stock exchanges in China — the Shenzhen Stock Exchange.

It is the world's ninth-largest stock exchange by market capitalization and eighth-largest by number of listed companies.

The SZSE works similarly to other stock exchanges around the world. Buyers and sellers place orders with their brokers, who then send orders to the stock exchange. The stock exchange matches the buy orders with sell orders, and when the match appears, executes the trade. The price of a share of stock depends on supply and demand. 

Example of a trade on the SZSE

Imagine you are an investor in Shenzhen who wants to buy 100 shares of Tencent stock. First and foremost, you place an order with your broker, who would then send the order to the SZSE.

The SZSE will match your buy order with a sell order from another investor. If there are multiple sell orders for Tencent stock at the same price, the SZSE will execute the first placed order.

Once the trade finishes, you will own 100 shares of Tencent stock. And the stock seller receives the sale proceeds, minus securities and exchange commission.

Major stock exchanges in the US

The two largest national stock exchanges in the United States are the New York Stock Exchange (NYSE) and the Nasdaq Stock Market.

  • New York Stock Exchange (NYSE). The NYSE is the largest stock exchange in the world by market capitalization. It is also one of the oldest stock exchanges. The NYSE is home to many of the world's largest and most well-known companies, such as Apple, Microsoft, and Berkshire Hathaway.
  • Nasdaq Stock Market. The Nasdaq is the second-largest stock exchange in the world by market capitalization. It is known for being a technology-focused exchange. However, there are also many companies from other industries listed on the Nasdaq, such as consumer staples, healthcare, and financials.

In addition to the NYSE and Nasdaq, there are several smaller stock exchanges in the United States, such as the Chicago Stock Exchange and the Boston Stock Exchange. However, the NYSE and Nasdaq are by far the most important stock exchanges in the country.

Among other global market makers who significantly influence stock exchanges are London Stock Exchange (LSE), Tokyo Stock Exchange (TSE), and Euronext. 

Benefits and risks of investing in stock exchanges

Investing in stock exchanges is both risky and rewarding. So let us look at the main pros and cons of such activity. 

Pros

  1. Potential for Capital Growth. Stocks have historically offered the potential for significant long-term capital appreciation. Over time, well-chosen stocks outpace inflation and generate wealth.
  2. Dividend Income. Many stocks pay dividends to shareholders, providing a regular income stream. 
  3. Portfolio Diversification. Investing in various stocks allows you to diversify your portfolio, spreading risk across different companies, industries, and sectors. Diversification reduces the impact of poor-performing investments.
  4. Liquidity. Stock markets are highly liquid, meaning you can buy and sell stocks relatively quickly and easily, especially for well-traded companies. 
  5. Ownership Stake. When you buy stocks, you become a partial owner of the company. The more stocks you buy, the more rights you have.

Cons

  1. Market Volatility. Stock prices are highly volatile, leading to significant short-term price fluctuations. 
  2. Risk of Loss. The value of stocks can decline, and you will lose a portion or all of your invested capital if stock prices drop significantly.
  3. Economic and Market Risks. Such factors as economic downturns, market crashes, and geopolitical events negatively impact stock prices and investor portfolios.
  4. Company-Specific Risks. Individual companies can face operational, financial, or management issues that affect their stock prices. 
  5. Psychological Risk. Investors tend to make emotional decisions based on fear or greed, leading to buying high and selling low.

Keep in mind that investing in the stock markets involves many risks, and you can easily lose all your capital if you are poorly prepared. Take time to learn with this comprehensive guide before turning to stock exchanges. Put all the odds on your side if you want to win on the auction markets.