Types of Stock Exchanges

What Are Stock Exchanges?

Stock exchanges are organized marketplaces where shares of ownership in companies are traded between buyers and sellers. These exchanges play a vital role in the global economy by providing a centralized location for businesses to raise capital and investors to buy and sell securities. While the concept dates back to 17th-century Amsterdam, modern stock exchanges have evolved into sophisticated, often digital, platforms for rapid, high-volume trading.

This article will explore how these exchanges operate and their impact on individual investors and the broader economy. We'll review key concepts like initial public offerings (IPOs), market indices, and the difference between primary and secondary markets. By understanding stock exchanges, investors can better navigate the complex world of equity investing and grasp how these institutions shape the financial landscape.

How Exchanges Work

A stock exchange is a marketplace where financial instruments, primarily equities (stocks) and bonds, are traded. These bustling hubs bring corporations and governments with investors, processing trades in real time when the markets are open. Think of exchanges as highly organized auction houses for pieces of companies and government debt.

The journey of a stock to an exchange begins with an IPO. During an IPO, a company sells shares to a set of public shareholders in what's known as the primary market. After the IPO floats shares into the hands of public shareholders, these shares can be freely bought and sold on an exchange, now part of the secondary market.

At that point, the ebb and flow of supply and demand determines a stock's price. The exchange tracks the flow of orders for each stock and relays this information to all participants. For example, an asking price of $41 means that a seller is willing to part with their shares for $41. The $1 difference between this price and, say, the $40 bid someone makes is called the bid-ask spread, representing the cost of the transaction.

Modern exchanges run predominantly through electronic systems, enabling lightning-fast transactions and real-time price updates. However, some exchanges, like the New York Stock Exchange (NYSE), still have a physical trading floor alongside their electronic systems.

Types of Stock Exchanges

There are a few different types of stock exchanges, each with unique features. It's important to understand how each works:

Auction Exchanges

Auction exchanges, also called open outcry systems, are where buyers and sellers put in competitive bids simultaneously. The stock price is the highest price a buyer is willing to spend on a security, and the seller accepts the lowest prices. Trades are matched, and the order is executed.

Brokers and traders communicate physically and verbally on the trading floor or pit to buy and sell securities. Although this system has mostly been replaced by electronic trading, some exchanges, including the NYSE, still use the auction system; the NYSE closing auction is the last event of the trading day when the closing price for each stock is determined by bringing all buyers and sellers together.

Dealer Markets

Dealer markets rely on specific dealers to facilitate transactions rather than using an auction system. Dealers post prices at which they buy and sell specific stocks, and they profit from the bid-ask spread.

Electronic Exchanges

Electronic exchanges don't rely on a single physical location. Instead, trades happen online without the need for dealers. The rise in electronic exchanges has helped give rise to high-frequency and algorithmic trading systems.

Over-the-Counter

OTC exchanges are where investors can buy and sell stocks that aren't traded on major centralized exchanges. They typically rely on broker-dealer networks. OTC stocks usually fail to meet listing requirements for other exchanges, meaning that they have very low market capitalization or can't afford the fee to get listed on an exchange like the NYSE of Nasdaq. OTC markets also include cryptocurrencies, foreign currencies, and certain derivatives.

Major US Exchanges

New York Stock Exchange (NYSE)

The NYSE is the world's largest equities exchange. The parent company of the NYSE is the Intercontinental Exchange (ICE) due to the merger with the European exchange Euronext in 2007.

The NYSE remains one of the world's leading auction markets, meaning specialists are physically present on its trading floors. Each specialist specializes in a particular stock, trading the stock in the auction. Companies listed on the NYSE meet initial listing requirements and follow annual maintenance requirements.

Investors who trade on the NYSE benefit from a set of minimum protections, which include a requirement that equity incentive plans must receive shareholder approval, the majority of the board of directors' members must be independent, the compensation committee must be entirely composed of independent directors, and the audit committee must include at least one person who possesses accounting or related financial management expertise.

Listing Requirements

To get listed on the NYSE, a stock must meet one of these requirements:

• Aggregate income over $10 million over the past three fiscal years income over $2 million in each of the past two fiscal years and more than $0 in the third year
• A minimum market capitalization of $200 million

In addition, the company must meet all these requirements:

• A minimum of 1.1 million publicly held shares
• A minimum market capitalization of $40 million
• A minimum share price of $4

Nasdaq

The Nasdaq is where buyers and sellers are only connected by computers over a network. Nasdaq is one of the world's leading electronic exchanges. Market makers, also known as dealers, carry their inventory of stock. They stand ready to buy and sell stocks on the Nasdaq and post bid and ask prices.

The exchange has listing and governance requirements like the NYSE. If a company doesn't maintain these requirements, it can be delisted to an OTC market.

Listing Requirements

To get listed on the Nasdaq, a stock must meet one of these sets of requirements:

• Aggregate income over $12 million over the past three fiscal years, income over $2.2 million in each of the past two fiscal years, and more than $0 in the third year

Or

• Aggregate cash flows over $27.5 million in the prior three fiscal years, with no years of negative cash flow in the previous three fiscal years
• Average market capitalization over $550 million in the prior 12 months
• Revenue over $110 million in the previous fiscal year

Or

• Average market capitalization over $850 million in the prior 12 months
• Revenue over $90 million in the last fiscal year
  

Or

• Market capitalization over $160 million
• Total assets over $80 million
• Stockholders' equity over 80 million

In each case, the minimum bid price for a share must be $4.

Over-The-Counter (OTC)

OTC markets are those other than large organized exchanges. OTC markets generally list small companies or those delisted from other exchanges. The Over-the-Counter Bulletin Board (OTCBB) was an electronic community of market makers with no quantitative minimums for annual sales or assets required to list. The OTC Bulletin Board was closed in November 2021.

The term used for some OTC trading, Pink Sheets, doesn't require companies to register with the Securities and Exchange Commission (SEC). Liquidity is often minimal, and these companies are not required to submit quarterly 10-Qs. Some companies have deliberately switched to OTC markets to avoid the major exchanges' administrative burden, costs, and more robust regulations.

Listing Requirements

Though companies that trade OTC don't meet the listing standards of major exchanges, some organizations that facilitate OTC trades have their own listing requirements.

For example, OTC Market Group, which enables most OTC trades, requires that companies meet at least one of these requirements:

• Tangible assets over $5 million ($2 million if the company has operated for at least three years)
• Average revenue over $6 million for the last three years
• A bid price of $5 and one of the following: a net income over $0.5 million, $1 million in tangible assets, $2 million in revenue, or $5 million in total assets

Companies must all meet these requirements:

• A minimum bid price of $0.25
• A market capitalization of $10 million
• At least 50 shareholders owning at least 100 shares each

International Exchanges

Many exchanges are located throughout the world, including:

The Shanghai Stock Exchange is the largest in mainland China. Many investments are traded on the exchange, including stocks, bonds, and mutual funds. The Shenzhen Stock Exchange is the second-largest stock exchange operating independently in China.

Euronext is Europe's largest stock exchange, and although it has undergone multiple mergers, it was formed by the mergers of the Amsterdam, Paris, and Brussels stock exchanges. 

The London Stock Exchange is located in the United Kingdom. Within the LSE is the Financial Times Stock Exchange 100 Share Index. The “Footsie” contains the top 100 well-established publicly traded companies or blue-chip stocks.

In 2024, India surpassed Hong Kong as the fourth-largest stock market in the world by market capitalization. 

How To Invest in the Stock Market

Investing in the stock market is accessible to nearly everyone. Here's a step-by-step guide to get started:

1. Educate yourself: Before investing a single dollar, understand the basic financial concepts. Learn about stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Familiarize yourself with terms like diversification, asset allocation, and risk tolerance. Many free online resources, including Investopedia, can help build your knowledge base.
2. Determine your investment goals: Are you saving for retirement, a home down payment, or your child's education? Your goals will influence your investment strategy. For instance, long-term goals like retirement might allow for more aggressive, growth-oriented investments, while short-term goals may require a more conservative approach.
3. Assess your risk tolerance: This refers to how much market volatility you can stomach without much stress. Generally, younger investors can afford to take on more risk as they have time to rebound financially from market downturns. However, risk tolerance is also a personal factor: some people simply sleep better at night with less risky investments.
4. Choose where you'll have an investment account: For most beginners, opening a brokerage account is the easiest way to start investing. Online brokers like Fidelity, Charles Schwab, or Vanguard offer user-friendly platforms. (For help, Investopedia has put together its best online brokers for beginners). If you're saving for retirement, consider tax-advantaged accounts like a 401(k) through your employer (who might also provide some matching fund) or an individual retirement account.
5. Start with low-cost index funds: For newer investors, low-cost index funds or ETFs that track broad market indices (like the S&P 500) are often recommended; they're also the wise choice of many experienced investors who know how frequently they outperform specialists choosing their own mix of stocks and other securities. These provide instant diversification and lower fees than actively managed funds.

Remember, investing in the stock market involves risk, and it's normal for the value of your investments to fluctuate. Financial advisors often argue that the key is maintaining a long-term perspective and avoiding making emotional decisions based on short-term market movements.

Brokerage Houses

If you want to start investing, you need to open an account with a brokerage. In general, there are two types of brokerages, full-service brokerages and discount brokerages.

Full-Service Brokerages

Full-service brokerages offer a larger suite of services. Beyond just facilitating your investments, they may provide investment advice, financial planning services, accounting services, and more.

Often, you can work with a full-service brokerage to have someone else handle your investments on your behalf. You will, however, have to pay a fee for this service. Often, you'll pay as much as 1% or 2% of the amount you have invested each year.

If you have complex finances or want help with managing your money, this type of brokerage may be a good fit.

Discount Brokerages

Discount brokerages are brokerages that focus more on price than on offering a variety of services. While they may lack things like investment advisors or financial planning services, they charge much lower fees. Some don't even charge a commission for the trades you make.

If you feel confident in your ability to manage your finances and make good investment choices or feel that you don't have complex finances, a discount broker can help you save a lot of money.

Alternative Trading Systems

Electronic communication networks are part of an exchange class called alternative trading systems (ATSs). Regulated by the SEC, alternative trading systems electronically match orders for buyers and sellers. An ATS is not a national securities exchange but is considered a "dark pool." 

Dark Pools

Dark pools are private exchanges for trading securities that are not accessible by the investing public. Also known as "dark pools of liquidity," these markets allow institutional investors to buy or sell large blocks of shares without revealing their intentions to other market participants.

Unlike traditional stock exchanges, dark pools do not display bid and ask prices to the public—hence their name. The lack of transparency allows large players to trade without significantly impacting the market price, which could happen if a large order was placed on a public exchange.

While dark pools serve a legitimate purpose in the financial ecosystem, they have also faced criticism. Critics argue that dark pools create an uneven playing field, giving large institutions an unfair advantage over retail investors. There are also concerns about potential conflicts of interest, particularly when the dark pool operator is also a major trader.

Cryptocurrency Exchanges

Coinbase is the largest U.S. cryptocurrency exchange by value traded. Its trading platform enables cryptocurrency trading for retail investors and custodial accounts for institutions. Although Bitcoin is the most popular cryptocurrency, others traded include Ethereum and Litecoin.

Coinbase is licensed as a cryptocurrency exchange in multiple U.S. states. Binance is a major global exchange for cryptocurrencies, claiming an average trading volume of 65 billion per day.

The Bottom Line

Stock exchanges are the backbone of the global financial system, providing essential platforms for companies to raise capital and investors to trade securities. From traditional open outcry pits to modern electronic networks, exchanges have evolved to meet the changing needs of market participants.

While each type of exchange—open outcry, electronic, dealer markets, or OTC—has specific characteristics, they all serve the fundamental purpose of enabling price discovery and easy trading. Understanding these different exchange types is crucial for investors navigating today's complex financial landscape.