What Is the Stock Market?

The term "stock market" refers to the various exchanges where shares of publicly traded companies are bought and sold. These financial transactions take place on formal exchanges and through over-the-counter (OTC) markets that are subject to a set of regulations.

The terms "stock market" and "stock exchange" are often used interchangeably. In the stock market, traders buy or sell shares on one or more of the stock exchanges that make up the larger stock market.

The most prominent stock exchanges in the United States are the New York Stock Exchange (NYSE) and the Nasdaq.

Understanding the Stock Market

The stock market connects buyers and sellers of securities, enabling them to interact, negotiate and make trades. It facilitates the determination of prices for shares of companies and serves as an indicator for the overall economy. Buyers and sellers can be confident of fair prices, high liquidity, and transparency as market participants engage in open competition.

The first stock market was the London Stock Exchange, which started as a meeting place for traders to exchange shares in a coffeehouse in 1773. The first stock exchange in the United States was established in Philadelphia in 1790. In 1792, the Buttonwood Agreement, signed by 24 traders under a buttonwood tree, marked the beginning of New York's Wall Street. It was the first American organization of its kind to trade securities. In 1817, the traders renamed their venture to the New York Stock and Exchange Board.

The stock market is a regulated and controlled environment. In the US, the main regulatory bodies are the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

In the past, stock markets dealt in paper-based physical share certificates. Today, stock markets operate entirely electronically.

How the Stock Market Works

Stock markets offer a secure and regulated environment where market participants can confidently trade shares and other eligible financial instruments with minimal operational risk. They operate under the rules set by the regulator and serve as primary and secondary markets.

As a primary market, the stock market enables companies to raise capital by issuing and selling shares to the public for the first time through the process of an initial public offering (IPO). This allows companies to raise necessary funding from investors.

A company can divide itself into multiple shares and sell a portion of them to the public at a specific price per share. To do this, the company needs a marketplace where these shares can be sold, which is provided by the stock market. A publicly listed company may also offer new or additional shares through other offerings later on, such as rights issues or follow-on offerings, or even buy back or delist their shares.

Investors purchase shares of a company with the expectation of the value of the shares increasing or receiving dividends, or both. The stock exchange facilitates this process and charges a fee for its services to the company and its financial partners.

Investors can also buy and sell securities they already own through the stock exchange in the secondary market. The stock exchange also tracks and provides indicators such as the S&P 500 and Nasdaq 100 which measure the overall market performance.

What Are the Functions of a Stock Market?

The stock market promotes transparency, liquidity, fair pricing and fair trading practices. It makes sure that all market participants have access to buy and sell order data which aids in fair pricing of securities, it also facilitates matching of suitable buy and sell orders efficiently.

In order to function properly, stock markets facilitate the process of determining the price of a stock through the collective actions of buyers and sellers, known as price discovery. The market should also provide instant access for qualified and willing traders to place orders and guarantee that those orders are executed at a fair price.

Participants in the stock market include market makers, investors, traders, speculators, and hedgers. An investor may purchase stocks and hold onto them for an extended period, while a trader may rapidly enter and exit a position. Market makers ensure liquidity in the market, and hedgers may trade in derivatives.

How Stock Markets Are Regulated

Each country has its own stock market, which is overseen by a local financial regulator, monetary authority or institute. In the United States, the Securities and Exchange Commission (SEC) is responsible for regulating the stock market.

The Securities and Exchange Commission (SEC) is a federal agency that operates independently from the government and without political influence. Its mission is to protect investors, ensure fair, orderly, and efficient markets and to promote capital formation.

Companies that are listed on stock market exchanges are subject to regulation and oversight by the SEC. Additionally, the exchanges establish specific requirements such as mandatory timely filing of quarterly financial reports and prompt reporting of significant corporate developments to ensure that all market participants have equal access to information.

Not adhering to the regulations can result in suspension of trading and other penalties.

What Is the Significance of the Stock Market?

The stock market is a fundamental aspect of a free-market economy. It enables companies to raise funds by issuing stock shares and corporate bonds, and enables investors to benefit from the financial success of these companies through capital gains and dividends. The stock market serves as a conduit through which individuals' savings and investments are directed towards productive investment opportunities, contributing to the economic growth and capital formation of the country.

What Is an Alternate Trading System?

Alternative trading systems are platforms for matching large buy and sell transactions, which are not subject to regulation in the same way as traditional exchanges. Dark pools and many cryptocurrency exchanges are private platforms or forums for securities and currency trading, which operate within closed groups.

Who Helps an Investor Trade on the Stock Market?

Stockbrokers act as intermediaries between the stock exchanges and investors, by facilitating the buying and selling of stocks. Portfolio managers are professionals who manage collections of securities on behalf of clients. Investment bankers act as representatives for companies in various capacities, such as private companies seeking to go public through an IPO or companies involved in mergers and acquisitions.