Learn How Wall Street Works
The term "Wall Street" has come to mean two things in the modern vernacular of finance: a place where trading occurs, and a figure of speech for any of the capital markets.
Two Meanings of Wall Street
Wall Street is is the name of a street in lower Manhattan that is home to the New York Stock Exchange and financial institutions that have been around for centuries. You can go to Wall Street and stand surrounded by offices that collectively control trillions of dollars in wealth.
Wall Street is also a metonymy, or figure of speech, for capital market finance. The term is frequently used to describe a person, institution, or activity tied to high finance and banking.
For example, American Century Investments is an asset management company in Kansas City, Mo., that oversees more than $1 trillion, mostly through mutual funds and institutional relationships. It is located in the heart of the Midwest, surrounded by plains a few miles out from its headquarters at the Country Club Plaza. It is nowhere near Wall Street physically, but it is very much a part of what people think of when they discuss the activity of portfolio managers, retirement plan administrators, and such.
Understanding the Role of Wall Street
Wall Street, both the physical place and the metonymy, exists for three primary purposes:
1. To establish a market for institutions to raise capital through a centralized trading area that connects savers of capital with those who want to raise capital. Wall Street trading can come in many forms, including but not limited to, the issuance of bonds or the sale of ownership in a business through the issuance of stocks. Wall Street makes capitalism work by — with the support of government regulations — moving money efficiently to its most productive uses.
2. To facilitate a secondary market for existing owners of stocks and bonds to find parties willing to buy their securities so they can raise cash. This facilitation makes markets more successful, as investors have more confidence in the ability to use their portfolio as a source of liquidity. As a result, lower risk premiums are usually demanded.
3. To assist those who wish to outsource the job of investing their capital so the client can focus on their primary career or activity. This outsourcing is sometimes done through broker-dealers. Increasingly, this is done through registered investment advisers bound by a fiduciary duty to put the interests of clients above theirs. Such advisers include those that are primarily asset management companies. In turn, if you are a high-earning and successful individual, you can pay someone else to handle your portfolio as you focus on generating more money and not on reading 10-K filings or mutual fund prospectuses.
Wall Street is essentially a repository for investments across a variety of different securities.
When people think of Wall Street, they usually have the secondary market in mind—i.e., the buying and selling of existing shares of outstanding stocks by individual investors through their retirement and brokerage accounts. They are especially interested in the daily fluctuations of the major stock market indices, such as the Dow Jones Industrial Average and S&P 500.
Trading on Wall Street
Trading on all types of markets, including the stock and bond markets that comprise Wall Street, involves a multitude of factors and mechanisms that affect prices. You will find market makers that are central to all trading exchanges. These market makers, also known as broker-dealers, are integrated into the trading system to facilitate the flow of money and trades.
Generally, most investors believe that the prices of traded securities are based on factors such as management changes, news events, and corporate actions. What many investors often do not realize is that market makers and the supply and demand for a traded security on any given day may also have a large impact on a security's trading price.
Market makers come in several forms, ranging from individuals located on the exchange floors to electronic communication networks. Every transaction on an exchange requires a counterparty willing to take the opposite side of the trade. Market makers work as a go-between and earn a small fee for their service in the process.