What Are Stock Exchanges and How Do They Work?

What Is a Stock Exchange?

A stock exchange is a physical or electronic venue wherein the sale of securities like stocks is facilitated by brokers, dealers, and market makers. Stock exchanges are essentially marketplaces for the efficient trading of stocks between unrelated parties based on supply and demand.

The two major American stock exchanges are the NYSE (New York Stock Exchange) and the Nasdaq (National Association of Securities Dealers Automated Quotations). The Amsterdam Stock exchange is the world’s first and oldest. Established by the East India Company in 1602, the exchange is now owned by Euronext.

Stock exchanges allow investors to trade shares of companies’ stock (along with ETFs and certain other securities) without actually having to locate and transact with individual buyers or sellers. In the past, shares were bought and sold in person on exchanges’ trading floors by brokers, and while this still occurs to a lesser extent today, most modern exchange transactions are conducted electronically because electronic trading is cheaper and faster.

The brokers, dealers, and market makers who facilitate transactions within stock exchanges must be licensed members of the exchange. Similarly, to be listed on and traded via an exchange, companies must pay listing fees and meet certain requirements that may include a minimum number of shares or shareholders and/or the maintenance of a minimum stock price.

Why Do Stock Exchanges Exist? Why Are They Important?

Stock exchanges exist to provide a centralized venue through which buyers and sellers can exchange securities in a safe, regulated, and orderly manner. Instead of manually seeking out a buyer for a stock they want to sell, an investor can simply access an exchange via an electronic broker.

Exchanges also provide the liquidity necessary for investors to be able to buy and sell stocks and other instruments in a timely manner. They do this by creating a place where many investors (and market makers—usually banks—who are willing to buy and sell large numbers of shares at any given time) are brought together.

Because so many shares are traded on major exchanges each day—and because market makers exist to provide additional liquidity—it is fairly easy for an investor to buy or sell shares of a stock at its current market price rather than having to wait to be connected to a compatible party as a stock’s price continues to change in the interim.

Why Are Stock Exchanges Known as the “Secondary Market?”

A primary market is one in which securities are created for the first time. For instance, if an investor were to buy a municipal bond directly from a county government, they would be doing so on the primary market.

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TheStreet Dictionary Terms

A secondary market, on the other hand, is one in which existing securities can be traded by investors. Since stock exchanges serve this second purpose, they are considered secondary markets.

What Are the Two Major American Stock Exchanges?

As mentioned above, the two major American stock exchanges are the NYSE and the Nasdaq. The NYSE is larger and older, but the Nasdaq was the first exclusively electronic exchange and is home to many of today’s top technology-industry stocks, including Google parent Alphabet and Facebook parent Meta.

The NYSE vs. the NASDAQ at a Glance

The market cap and listings data in this table are from Statista.
	NYSE	Nasdaq
Created	1792	1971
Market Cap (Jan. 2022)	$28.26 Trillion	$22.46 Trillion
Companies Listed (Dec. 2021)	2,434	3,566
Market Type	Auction	Dealer

While the NYSE is the larger exchange by market cap, the Nasdaq hosts the most individual companies. The Nasdaq also offers lower listing fees, and its listing requirements are less stringent than those of the NYSE.

Dealer Exchanges vs. Auction Exchanges: What’s the Difference?

In dealer exchanges—like the Nasdaq—many liquidity-providing market makers are in competition. For any given security, each market maker provides two prices: one lower price at which they are willing to purchase the security, and one higher at which they are willing to sell the security. Investors looking to buy then buy from the dealer offering the lowest price. Investors looking to sell then sell to the dealer offering the highest price.

This is in contrast to an auction market—like the NYSE—in which a centralized entity analyzes all of the bids (buy offers) and asks (sell offers) for a particular security and matches the highest bid to the lowest ask to create the current trading price of that security.

What Do Brokers and Market Makers Do in a Stock Exchange?

Within a stock exchange, a broker is a licensed trading professional who buys and sells stocks and other securities on an investor’s behalf. Brokers can be real people or trading platforms like Robinhood or E-Trade.

A market maker, on the other hand, is a bank or financial institution that provides liquidity to a market by buying shares whenever someone needs to sell them and selling shares whenever someone needs to buy them. In exchange for the liquidity they provide, market makers profit from the difference between the bid and the ask in each trade they facilitate. This difference is known as the bid-ask spread.

How Are Stock Exchanges Regulated?

According to the Securities and Exchange Commission, exchanges (like the Nasdaq and NYSE) and the parties that facilitate their operation (like broker-dealers and market makers) must adhere to standards set by the Division of Trading and Markets to ensure the “fair, orderly, and efficient” exchange of securities.

What Are Some Major Non-American Stock Exchanges?

The NYSE and the Nasdaq are the two major American stock exchanges and are also the two largest stock markets in the world. Other major exchanges include the following: