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A stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately.
Although common, the term 'the stock market' is a somewhat abstract concept for the mechanism that enables the trading of company stocks. It is also used to describe the totality of all stocks and sometimes other securities, with the exception of bonds, commodities, and derivatives. The term is used especially to apply within one country as, for example, in the phrase "the stock market was up today", or in the term "stock market bubble". Bonds are still traditionally traded in an informal, over-the-counter market known as the bond market. Commodities are traded in commodities markets, and derivatives are traded in a variety of markets (but, like bonds, mostly 'over-the-counter'). The size of the worldwide 'bond market' is estimated at $45 Trillion; the size of the 'stock market' is estimated as about half that. The world derivatives market has been estimated at about $300 Trillion. The major U.S. Banks alone are said to account for about $100 Trillion. It must be noted though that the derivatives market, because it is stated in terms of notional outstanding amounts, cannot be directly compared to a stock or fixed income market, which refers to actual value. The stock market is distinct from a stock exchange, which is an entity (a corporation or mutual organization) in the business of bringing buyers and sellers of stocks and securities together. For example, 'the stock market' in the United States includes the trading of all securities listed on the NYSE, the NASDAQ, the Amex, as well as on the many regional exchanges, the OTCBB, and Pink Sheets. European examples of stock exchanges include the Paris Bourse (now part of Euronext), the London Stock Exchange and the Deutsche Börse. Trading Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. Their orders usually end up with a professional at a stock exchange, who executes the order. Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. (You've probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other.) This type of auction is used in stock exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders at computer terminals. Actual trades are based on an auction market paradigm where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any bid or ask price for the stock.) When the bid and ask prices match, a sale takes place on a first come first serve basis if there are multiple bidders or askers at a given price. The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace (virtual or real). Just imagine how difficult it would be to sell shares (and what a disadvantage you would be at with respect to the buyer) if you had to call around trying to locate a buyer, as when selling a house. Really, a stock exchange is nothing more than a super-sophisticated farmers' market providing a meeting place for buyers and sellers. The New York Stock Exchange is a physical exchange, where much of the trading is done face-to-face on a trading floor. This is also referred to as a "listed" exchange (because only stocks listed with the exchange may be traded). Orders enter by way of brokerage firms that are members of the exchange and flow down to floor brokers who go to a specific spot on the floor where the stock trades. At this location, known as the trading post, there is a specific person known as the specialist whose job is to match buy orders and sell orders. Prices are determined using an auction method known as "open outcry": the current bid price is the highest amount any buyer is willing to pay and the current ask price is the lowest price at which someone is willing to sell; if there is a spread, no trade takes place. For a trade to take place, there must be a matching bid and ask price. (If a spread exists, the specialist is supposed to use his own resources of money or stock to close the difference, after some time.) Once a trade has been made, the details are sent back to the brokerage firm, who then notifies the investor who placed the order. Although there is a significant amount of direct human contact in this process, computers do play a huge role in the process, especially for so-called "program trading". The Nasdaq is a virtual (listed) exchange, where all of the trading is done by computers. The process is similar to the above, in that the seller provides an asking price and the buyer provides a bidding price. However, buyers and sellers are electronically matched. One or more Nasdaq market makers will always provide a bid and ask price at which they will always purchase or sell 'their' stock. The Paris Bourse, now part of Euronext is an order-driven, electronic stock exchange. It was automated in the late 1980s. Before, it consisted of an open outcry exchange. Stockbrokers met in the trading floor or the Palais Brongniart. In 1986, the CATS trading system was introduced, and the order matching process was fully automated. |
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