The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place.
Such financial activities are conducted through institutionalized formal exchanges or marketplaces which operate under a defined set of regulations.
There can be multiple stock trading venues in a country or a region which allow transactions in stocks and other forms of securities.
While both terms – stock market and stock exchange – are used interchangeably, the latter term is generally a subset of the former. If one says that she trades in the stock market, it means that she buys and sells shares/equities on one (or more) of the stock exchange(s) that are part of the overall stock market.
The leading stock exchanges in the U.S. include and the leading national exchanges, along with several other exchanges operating in the country, from the stock market of the U.S.
Though it is called a stock market or equity market and is primarily known for trading stocks/equities, other financial securities – like and derivatives based on stocks, commodities, currencies, and bonds – are also traded in the stock markets. (For related reading,
Understanding the Stock Market
While today it is possible to purchase almost everything online, there is usually a designated market for every commodity.
For instance, people drive to city outskirts and farmlands to purchase Christmas trees, visit the local timber market to buy wood and other necessary material for home furniture and renovations, and go to stores like Walmart for their regular grocery supplies.
Such dedicated markets serve as a platform where numerous buyers and sellers meet, interact, and transact. Since the number of participants is huge, one is assured of a fair price.
For example, if there is only one seller of Christmas trees in the entire city, he will have the liberty to charge any price he pleases as the buyers won’t have anywhere else to go.
If the number of tree sellers is large in a common marketplace, they will have to compete against each other to attract buyers. The buyers will be spoiled for choice with low- or optimum-pricing making it a fair market with price transparency.
Even while shopping online, buyers compare prices offered by different sellers on the same shopping portal or across different portals to get the best deals, forcing the various online sellers to offer the best price.
A stock market is a similar designated market for trading various kinds of securities in a controlled, secure, and managed environment.
Since the stock market brings together hundreds of thousands of market participants who wish to buy and sell shares, it ensures fair pricing practices and transparency in transactions.
While earlier stock markets used to issue and deal with paper-based physical share certificates, the modern-day computer-aided stock markets operate electronically.
How the Stock Market Works
In a nutshell, stock markets provide a secure and regulated environment where market participants can transact in shares and other eligible financial instruments with confidence with zero- to low-operational risk. Operating under the defined rules as stated by the regulator.
The stock markets act as a primary market, the stock market allows companies to issue and sell their shares to the common public for the first time through the process of This activity helps companies raise the necessary capital from investors.
It essentially means that a company divides itself into a number of shares (say, 20 million shares) and sells a part of those shares (say, 5 million shares) to the common public at a price (say, $10 per share).
To facilitate this process, a company needs a marketplace where these shares can be sold. This marketplace is provided by the stock market.
If everything goes as per the plans, the company will successfully sell the 5 million shares at a price of $10 per share and collect $50 million worth of funds.
Investors will get the company shares which they can expect to hold for their preferred duration, in anticipation of rising in share price and any potential income in the form of payments.
The stock exchange acts as a facilitator for this capital raising process and receives a fee for its services from the company and its financial partners.
Following the first-time share issuance IPO exercise called the listing process, the stock exchange also serves as the trading platform that facilitates regular buying and selling of the listed shares.
This constitutes the secondary market. The stock exchange earns a fee for every trade that occurs on its platform during the secondary market activity.
The stock exchange shoulders the responsibility of ensuring and fair dealings in such trading activities. As almost all major stock markets across the globe now operate electronically, the exchange maintains trading systems that efficiently manage the buy and sell orders from various market participants. They perform the price matching function to facilitate trade execution at a price fair to both buyers and sellers.
A listed company may also offer new, additional shares through other offerings at a later stage, like through or through. They may even or their shares. The stock exchange facilitates such transactions.
The stock exchange often creates and maintains various market-level and sector-specific indicators, like the or, which provide a measure to track the movement of the overall market. Other methods include the
The stock exchanges also maintain all company news, announcements, and financial reporting, which can be usually accessed on their official websites.
A stock exchange also supports various other corporate-level, transaction-related activities. For instance, profitable companies may reward investors by paying dividends which usually come from a part of the company’s earnings. The exchange maintains all such information and may support its processing to a certain extent. (For related reading, see “
Functions of a Stock Market
A stock market primarily serves the following functions:
Fair Dealing in Securities Transactions: Depending on the standard the stock exchange needs to ensure that all interested market participants have instant access to data for all buy and sell orders thereby helping in the fair and transparent pricing of securities. Additionally, it should also perform efficient matching of appropriate buy and sell orders.
For example, there may be three buyers who have placed orders for buying Microsoft shares at $100, $105, and $110, and there may be four sellers who are willing to sell Microsoft shares at $110, $112, $115, and $120.
The exchange (through their computer-operated automated trading systems) needs to ensure that the best buy and best sell are matched, which in this case is at $110 for the given quantity of trade.
Efficient Price Discovery: Stock markets need to support an efficient mechanism for price discovery, which refers to the act of deciding the proper price of a security and is usually performed by assessing market supply and demand and other factors associated with the transactions.
Liquidity Maintenance: While getting the number of buyers and sellers for a particular financial security are out of control for the stock market, it needs to ensure that whosoever is qualified and willing to trade gets instant access to place orders which should get executed at the fair price.
Security and Validity of Transactions: While more participants are important for the efficient working of a market, the same market needs to ensure that all participants are verified and remain compliant with the necessary rules and regulations, leaving no room for default by any of the parties.
Additionally, it should ensure that all associated entities operating in the market must also adhere to the rules, and work within the legal framework given by the regulator.
Support All Eligible Types of Participants: A marketplace is made by a variety of participants, which include, investors, traders, and hedgers. All these participants operate in the stock market with different roles and functions.
For instance, an investor may buy stocks and hold them for the long term spanning many years, while a trader may enter and exit a position within seconds.
A market maker provides necessary liquidity in the market, while a hedger may like to trade in derivatives for mitigating the risk involved in investments. The stock market should ensure that all such participants are able to operate seamlessly fulfilling their desired roles to ensure the market continues to operate efficiently.
Investor Protection: Along with wealthy and institutional investors, a very large number of small investors are also served by the stock market for their small amount of investments.
These investors may have limited financial knowledge, and may not be fully aware of the pitfalls of investing in stocks and other listed instruments.
The stock exchange must implement necessary measures to offer the necessary protection to such investors to shield them from financial loss and ensure customer trust.
For instance, a stock exchange may categorize stocks in various segments depending on their risk profiles and allow limited or no trading by common investors in high-risk stocks.
Exchanges often impose restrictions to prevent individuals with limited income and knowledge from getting into risky bets of derivatives.
Balanced Regulation: Listed companies are largely regulated and their dealings are monitored by market regulators, like the of the U.S. Additionally, exchanges also mandate certain requirements – like, timely filing of quarterly financial reports and instant reporting of any relevant developments – to ensure all market participants become aware of corporate happenings. Failure to adhere to the regulations can lead to suspension of trading by the exchanges and other disciplinary measures.
Regulating the Stock Market
A local financial regulator or competent monetary authority or institute is assigned the task of regulating the stock market of a country. The Securities and Exchange Commission (SEC) is the regulatory body charged with overseeing the U.S. stock markets.
The SEC is a federal agency that works independently of the government and political pressure. The mission of the SEC is stated as: “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”1
Stock Market Participants
Along with long-term investors and short-term traders, there are many different types of players associated with the stock market. Each has a unique role, but many of the roles are intertwined and depend on each other to make the market run effectively.