How does a stock trade work?
To understand that, you have to understand how the financial trading system, i.e. the "stock market" works.
Several markets make up what is known as the stock market. Many stocks are traded on the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotations (NASDAQ), and the American Stock Exchange (Amex). In addition, such cities as Boston, Chicago, Philadelphia, Denver, San Francisco, and Los Angeles have exchanges, as do major international cities like London and Tokyo.
The NYSE
Also known as “The Big Board,” the New York Stock Exchange (NYSE) is home to the most prominent players like IBM, Google, and Disney. The Big Board is not for little league players. Among other requirements, a company must have at least 1.1 million public shares of stock outstanding, must show pretax income of at least $6.5 million over the three most recent fiscal years (each year has to be equal to or more than the previous year), and the company’s market value of public shares must be at least $40 million to be on board. In addition, the company’s most recent year’s pretax income must be at least $2.5 million, and its net tangible assets must be a minimum of $40 million.
The NYSE is a 36,000-square-foot facility located in the heart of the city’s financial district, which is wedged eastward between lower Broadway and the South Street Seaport, and extends all the way down to the southern tip of Manhattan. The oldest stock exchange in the United States uses an agency auction market system designed to allow the public to experience the actual trading as much as possible. Open bids and offers are relayed by NYSE members acting on behalf of institutions and individual investors. Buy and sell orders for each listed security meet directly on the trading floor in assigned locations. Every listed security is traded in a unique location, at one of the floor’s 17 trading posts.
The Specialist – a dying art?
Specialists (or specs) are members of the NYSE or American Stock Exchange (AMEX) who perform a unique function by acting as the focal point for trading the stocks assigned to them. Specialists play a significant but perhaps diminishing role on the NYSE. Whether they specialize in the shares of blue chips or of small growth companies, the job of the specialist is to help maintain fair and orderly markets in those stocks.
Each stock on the NYSE is allocated to a specialist, who trades only in specific stocks at a trading post. All buying and selling of stock occurs at that location. Buyers and sellers – represented on the floor by brokers meet openly at the trading post to find the best price for a security. The people who gather around the specialist’s post are referred to as the trading crowd. Bids to buy and offers to sell are made by open outcry (thus the perceived chaos on the floor!). When the highest bid meets the lowest offer, a trade is executed.
While the majority of volume (approx 88%) on the NYSE occurs with no intervention from the dealer, to a large degree, the specialist is responsible for maintaining the market’s fairness, competitiveness and efficiency. Although specialists cannot control the price of a stock, they are responsible for ensuring that changes in price are gradual, and that all customers have had a chance to participate at a given price.
Behind the frenzied spectacle that many outsiders picture when they think of the NYSE trading floor, however, is a methodical and organized system of trading in which the price of any stock is set purely by rule of supply and demand in an auction setting. Specialists help match buyers and sellers, but shares are always sold to the highest bidder.
The NASDAQ and the AMEX
The National Association of Security Dealers Automated Quotations (NASDAQ) and the American Stock Exchange (Amex) united in October 1998, creating the NASDAQ/Amex Market Group. The American Stock Exchange is now a subsidiary of the National Association of Securities Dealers, Inc. (NASD). By joining two of the world’s top securities markets, there is now an alliance creating an even more globally competitive market. However, the NASDAQ and the Amex are still currently operating as separate entities.
The NASDAQ is an over-the-counter (OTC) market, which is the term used to describe securities that are traded through telephone and computer networks as opposed to through an auction exchange (such as the American Stock Exchange).
The NASDAQ began operating in February of 1971, with 250 companies, as the world’s first electronic stock market. It has since evolved into a full-fledged stock market with over 7,000 companies listed. Trading volume broke the 500 million shares-per-day barrier back in 1996. Today, more initial public offerings (IPOs) are listed on NASDAQ than on any other U.S. stock market.
The NASDAQ market is an inter-dealer market represented by over 600 securities dealers trading more than 20,000 different issues. These dealers are called market makers (MMs). Unlike the NYSE, the NASDAQ market does not operate as an auction market. Instead, market makers are expected to compete against each other to post the best quotes (best bid/ask prices).
The NASDAQ has no single specialist through whom transactions pass. NASDAQ’s market structure allows multiple market participants to trade stock through a sophisticated computer network linking buyers and sellers from around the world. Together, these participants help ensure transparency ad liquidity for a company’s stock while maintaining an orderly market functioning under tight regulatory controls.
Two separate markets comprise the NASDAQ Stock Market: the NASDAQ National Market, which includes the NASDAQ’s largest and most actively traded securities; and the NASDAQ SmallCap Market for emerging growth companies.
The AMEX lists over 700 companies and is the world’s second largest auction marketplace. Like the NYSE, the AMEX uses an agency auction market system designed to allow the public as much access to public shares as possible.
In our next blog, we'll track the trading process -- so you'll know just what happens when you place your own stock trade.