What Is a Stock Exchange?

As a new investor, you'll discover that many of your stock trades are going to be placed on one of a handful of stock exchanges.  What is a stock exchange?  How many major stock exchanges are there in the world? Those are great questions. Let's take a look, so you understand the basics!

First, what is an exchange? Put simply; an exchange is an institution, organization, or association which hosts a market where stocks, bonds, options and futures, and commodities are traded. Buyers and sellers come together to trade during specific hours on business days. Exchanges impose rules and regulations on the firms and brokers that are involved with them. If a particular company is traded on an exchange, it is referred to as "listed."

Securities that are not listed on a stock exchange are sold OTC, which stands for Over-The-Counter. Companies that have shares traded OTC are usually smaller and riskier because they do not meet the requirements to be listed on a stock exchange. Many giant blue-chip stocks, such as Berkshire Hathaway, at one time traded on the over-the-counter market before migrating to the so-called "Big Board," or New York Stock Exchange.

When a business raises capital by issuing shares, the owners of those new shares are likely going to want to sell their stake someday. Maybe they have a child going to college and need to cover the tuition bill. Perhaps they pass away, and their estate is subject to some hefty estate taxes. They may even leave it to their grandchildren, who get to enjoy the stepped-up basis loophole, but the heirs want to liquidate to buy a house. Whatever is driving their decision, they aren't likely to tie up their funds unless they know somehow, someway, at some point in the future, they'll be able to find a buyer for their holdings without too much trouble in what is known as "the secondary market."

Without a stock exchange, these owners would have to go around to friends, family members, and community members, hoping to find someone to whom they could sell their shares. (Technically, you can do this. You don't have to sell your shares on a stock exchange. You can take physical possession of your stocks in certificate form, endorse them, and sign them over to someone in exchange for payment in your lawyer's office, or at your dining room table if you are so inclined. When the stock exchange was closed during World War I, many people did just that, creating a secondary shadow market.

The need for convenience is what led to the establishment of the biggest stock exchange in the world. In the United States, a group of stockbrokers met under a buttonwood tree in New York City. On May 17th, 1792, twenty-four of these stockbrokers got together outside of 68 Wall Street to sign the now-famous Buttonwood Agreement, which effectively created the New York Stock & Exchange Board. Almost three-quarters of a century later, in 1863, it was officially renamed the New York Stock Exchange. These days, most people refer to it as the NYSE.

At one time, the United States had thriving regional stock exchanges that were major hubs for their particular part of the country. In San Francisco, for example, the Pacific Stock Exchange had an open outcry system where brokers would handle buy and sell orders for local investors who wanted to purchase or liquidate their ownership stakes. Most of these were shut down, purchased, absorbed, or merged following the rise of the microchip, which made electronic networks much more efficient for finding liquidity so that an investor in California could just as easily sell his or her shares to someone in Zurich.

As of January 31st, 2015, the fifteen biggest stock exchanges in the world by market capitalization of listed securities are:

1. The New York Stock Exchange - Located in New York City; $19.223 trillion in listed market capitalization.
2. NASDAQ - Short for the "National Association of Securities Dealers Automated Quotation," this electronic stock exchange is located in New York City; $6.831 trillion in listed market capitalization.
3. London Stock Exchange - Located in London, England; $6.187 trillion in listed market capitalization.
4. Tokyo Stock Exchange - Formally known as the Japan Exchange Group, located in Tokyo, Japan; $4.485 trillion in listed market capitalization.

A stock exchange is where pieces of ownership in businesses (stocks) are bought and sold among investors.  A commodity exchange is where goods that come from the Earth, such as corn, soybeans, cattle, oil, silver, gold, coffee, and pork bellies are bought and sold among parties, frequently not just for investment purposes but for actual use in business operations.