What Is a Stock Exchange?
Stock Exchange Definition and Explanation for New Investors
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 below, so you'll understand the basics.
- Exchanges are marketplaces for the trade of securities, commodities, derivatives, and other financial instruments.
- Stock exchanges allow investors to buy and sell shares of a company among each other in a regulated and legitimate space.
- Companies may use an exchange to raise capital in the secondary market through an IPO.
- More than 80% of trading on the New York Stock Exchange is done electronically.
What Is an Exchange?
First, what is an exchange? Put simply, an exchange is a locale where things are traded—where producers and consumers, or buyers and sellers, meet, and things are bought and sold. For financial products, these things that are traded include stocks, bonds, commodities, currencies, derivatives, and so on.
Modern financial exchanges have evolved from open-outcry auctions literally on the curbside of the streets of New York or London to highly regulated and respected institutions, today dominated by electronic trading.
If a stock does not trade on a listed exchange, it can still trade in the over-the-counter (OTC) market, which is a less formal and less regulated venue. These OTC-traded shares typically will involve smaller (and riskier) companies, such as penny stocks, since they may not meet the listing requirements for established stock exchanges.
What Is the Purpose of a 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 downside is that there is no transparency. Nobody knows what the best price is for a given stock at any given moment in time. You could be selling your shares for $50 while the guy two towns over is getting $70.
With a stock exchange, you will never know the person on the other end of the trade. They could be halfway around the world. It could be a retired teacher. It could be a multi-billion dollar insurance group. It could be a publicly-traded mutual fund or hedge fund.
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 17, 1792, 24 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.
What Are the Major Stock Exchanges in the World?
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 Sept. 30, 2019, the 15 biggest stock exchanges in the world by market capitalization of listed securities include:
- The New York Stock Exchange: Located in New York City, it has over $23 trillion in listed market capitalization. It has been around since the year 1792.
- NASDAQ: Short for the "National Association of Securities Dealers Automated Quotation," this electronic stock exchange is located in New York City and has over $11 trillion in listed market capitalization.
- Tokyo Stock Exchange / Japan Exchange Group: Located in Tokyo, Japan, it has over $5 trillion in listed market capitalization.
- Shanghai Stock Exchange: Located in Shanghai, China, it has over $4 trillion in listed market capitalization.
- Euronext: Located throughout Europe (France, Portugal, the Netherlands, and Belgium), it has over $4 trillion in listed market capitalization.
- Hong Kong Exchanges and Clearing: Located in Hong Kong, Hong Kong, it has almost $4 trillion in listed market capitalization.
- London Stock Exchange: Located in London, England, it has almost $4 trillion in listed market capitalization.
- Shenzhen Stock Exchange: Located in Shenzhen, China, it has over $3 trillion in listed market capitalization.
- TMX Group: The Canadian stock exchange is located in Toronto, Canada, and has over $2 trillion in market capitalization.
- Bombay Stock Exchange / BSE India Limited: Located in Mumbai, India, it has over $2 trillion in market capitalization.
- National Stock Exchange of India: Located in Mumbai, India, it has over $2 trillion in market capitalization.
- Deutsche Börse AG: The German stock exchange, located in Frankfurt, Germany, has almost $2 trillion in market capitalization.
- SIX Swiss Exchange: The Zurich stock exchange, located in Zurich, Switzerland, has almost $2 trillion in listed market capitalization.
- Nasdaq Nordic and Baltics: Located in Stockholm, Sweden, it has over $1.4 trillion in listed market capitalization.
- ASK Australian Securities Exchange: Located in Sydney, Australia, it has over $1.4 trilled in listed market capitalization.
What Is the Difference Between a Stock Exchange and a Commodity Exchange?
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.
Vanguard. "Stock Exchanges." Accessed Dec. 30, 2019.
FINRA. "Unraveling the Mystery of Over-the-Counter Trading." Accessed Dec. 30, 2019.
Library of Congress. "Wall Street and the Stock Exchanges: Historical Resources." Accessed Dec. 30, 2019.
World Federation of Exchanges. "Market Statistics October 2019." Accessed Dec. 30, 2019.
Investor.gov. "Commodities." Accessed Dec. 30, 2019.