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How a stock exchange works; everything you need to know about basics of stock exchange

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If you search online or look up the basic definition of the stock exchange, it will be “A platform where people buy and sell the shares of stocks”. Search more and you’ll learn something like “the stock market is where companies have their stock listed and investors can go through any stock they choose to buy. This definition may not really be enough for you to understand what a stock exchange is.

This is because the stock market and other trading-related activities are usually taught in such a way that makes it feel like it is necessary for one to have a financial or technical background. We will show you the simplest ways to understand the stock exchange without making it overly complicated.

Let’s start with an example. Let’s imagine you are at a science fair. There are many teams participating in this science fair. You and other visitors are here to see which team presents a new and successful seeming project. Each team presents their science model. Then one of the teams presents a very attractive, promising model or wins a top prize at the fair. This model prompts you and others to somehow invest in it, hoping to see that the future success of this model in the market and public may bring profitable returns for your investment.

The stock market works similarly to this example. The stock market is like the science fair, which is a platform that brings visitors and teams together. The Stock market brings buyers and sellers together. The teams at the science fair presenting their models are known as companies or sellers in the stock market. These companies place their stocks on the stock exchange’s listing. The visitors and participators who want to invest in the team’s models are called buyers or investors who wish to invest in the company’s stock.

Types of stock exchanges

Of course, this was just an example of explaining how a stock exchange works in the simplest of ways. However, there are many other aspects that we would like to cover that are not part of this comparison.

Let’s now look at what types of stock exchanges are there.

Auction-based stock exchange; trader’s floor

There is the centralized physical location of the stock exchange, where buyers and sellers verbally communicate and physically exchange shares of stock. These physical stock exchange platforms are known as auction-based exchanges where the traders are physically on the exchange floor.

Electronic-based exchange; screen-based platform

The second way stock exchanges exist is through electronic-based platforms where exchanges take place electronically. This means that there is no need for a physically centralized platform for traders to meet. Out of both major types of exchanges, we consider the electronic stock exchange much more efficient. Recently, more and more exchanges are phasing out the auction-based exchange system for the electronic exchange platform.

NYSE and Nasdaq

We will learn more about the type of stock exchange by going over the two most famous ones in the world.

Starting with the New York Stock Exchange is one of the world’s largest physically traded exchanges. It is also the largest equities exchange in the world and in Wall Street it is known as “The Big Board” since its origination in 1792. NYSE transformed from a private to a public entity in March 2006. It is mainly owned by Intercontinental Exchange. NYSE comprises both electrical exchange platforms and an auction-based exchange platform. NYSE has mainly designated market makers for different stocks on its physical exchange floor. These deal makers then physically interact with the buyers and sellers face-to-face on the auction floor.

Let look at the electronic exchange realm. Particularly at the world’s largest electronic-based stock exchange, which is Nasdaq. Nasdaq stands for National Association of Securities Dealers that came into existence in February 1971. It comprises deal makers that are connected with stock buyers and stock sellers. The electronic mediums of connection between them are screen and computer-based displays of the listings of stocks in the Nasdaq exchange. It places deals through a certain type of trader known as the market makers or dealers. These dealers can be individuals or firms that make deals incentivized for their own benefits. They generate by selling shares at higher bids and buying quotes at the cheaper bid.

Now that you know about NYSE and Nasdaq. The next thing you need to know is what is the underlying functioning of stock exchanges. This includes regulations and requirements for companies that are listed.

Requirements and Regulations

Stock exchanges like Nasdaq and NYSE have regulations and eligibility criteria for the stocks that are enlisted in them. If certain stocks of companies fall off the requirements and eligibility criteria of the exchange, then they are removed or delisted from the exchange.

The general requirements of these stock markets include the initial listing consideration fees and the entry fees upon successful listing. These fees can reach up to thousands of dollars. There is also a minimum number of shareholders and stockholder equity that is considered.

They specifically placed these restrictions to ensure that the stocks can maintain their credibility for all those involved. This credibility automatically allows investors and traders to know that only companies with relatively good corporate and financial management track records are placed on these stock exchanges. These exchanges then also require the listed companies to provide maintenance fees as part of an ongoing minimum standard.

When a company does not meet these ongoing requirements, they are served a notice for non-compliance or deficiency notice. After a certain period like 90-days in the case of Nasdaq, these companies are then delisted from the stock exchange if not brought back to the standards. One of the most important ongoing requirements includes the minimum bid price and minimum market value of a certain stock in the exchange.

Also, there are other regulations imposed on these stock exchanges and stocks, which are placed by government or financial regulatory bodies. For example, the Securities and Exchange Commission, known as the SEC, specifically has stringent requirements for fair and transparent trading. Penalties and repercussions, including blacklisting of the company, heavy fines, and criminal charges, are some punishments imposed if companies don’t comply with SEC regulations.

Other platforms for stock trading

The OTC market

Other types of markets for stocks where buyers and sellers can get shares are known as the Over-The-Counter markets or known as OTC. The OTC markets are usually markets where small companies that could not make it to the exchange listing or are delisted, usually trade. However, OTC markets have less stringent and credibility-check requirements for the companies listed on them. This makes the background info on the companies’ management and activities less transparent.

Pink Sheets

Pink sheets are another type of market service for trading. Here, quotation services are provided. However, these market services do not require companies to register with the Securities and Exchange Commission. Neither do these companies have to report their filings periodically, which makes Pink sheets even riskier than OTC.

A review of the stock exchange

First, a company has to comply with the listing procedure of the stock exchange. Once it has been deemed eligible, it is then officially known as a publically traded company. The publically traded company has to provide an Initial Public Offering (IPO) of its stock. In an IPO, the stock price is determined by the demand and supply of its stock shares.

The company is now listed. Therefore, the public can now invest in the company through its stock. Various other players, like deal makers and brokers, will start trading the share of this company’s stock. The company has to make sure that it complies with the ongoing requirements and the regulations set by the SEC.

Overall, this is how the companies can expand and grow their investments publically by listing in the stock exchange.

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