A stock exchange (sometimes called a securities exchange or, especially in Europe, a bourse) is both a physical facility and an organization or company that facilitates the trade of stock shares and other securities. Because so much trading is conducted outside the physical facility—electronically or through brokers—there are fewer regional stock exchanges than there once were; more than half of the stock exchanges in the United States closed or merged with others during the 20th century, as the business of exchange reduced the need for a separate stock exchange in Arizona, Buffalo, Louisville, and so forth. Although the terms are sometimes conflated in casual speech, the stock market and the stock exchange are not synonymous; the market consists of all the trade conducted on all the exchanges, or all the exchanges of a large region. The American stock market, for instance, includes all the trading done at the various stock exchanges in the country, as well as over-the-counter trades.
Role In The Economy
Stock exchanges began as mutual societies owned and run jointly by the brokerages who participated in them, like a mall owned by its stores. The Dutch East India Company led the way in selling stock in its company, doing so for the first time in 1602 on the Amsterdam Stock Exchange. The London Stock Exchange opened in 1688, and more European and American exchanges followed. The first American exchange was the Philadelphia Stock Exchange, in 1790 (it was bought by NASDAQ in 2007); the New York Stock Exchange opened in 1817, succeeding a 1792 trading agreement (the buttonwood agreement, named for the tree under which it was signed) between two dozen New York brokers.
At the end of the 20th century, some stock exchanges began demutualizing—going public, turning the mutual society into a corporation. NASDAQ and the NYSE have both gone public in the 21st century, and as a result of the NYSE’s merger with Euronext, the first “global exchange” is a publicly traded corporation. Between this shift in exchange ownership, the development of electronic trading and algorithmic trading discussed below, and the failure of investment banks in the wake of the 2007–08 financial crisis, the 21st century is seeing the shape of Wall Street, the stock market, and the world’s stock exchanges transform more radically than they have done since the aftermath of the Great Depression.
The fundamental role of the stock exchange has been in the service of business—raising capital by selling shares to the public, enabling mergers and acquisitions to facilitate growth—but the nature of investment has taken on a life of its own. Investing in the partial business ownership represented by stock shares long ago ceased to be principally the activity of professionals. Stock ownership is a common part of many Americans’ investment portfolios as they plan for retirement or midlife expenses like college tuition, and casual investing has become quite popular—especially with the advent of e-trading and online access to brokers and stock tips—among Americans of all walks of life.
The market itself is widely used as an indicator of economic health, putting the exchanges under scrutiny whenever major events occur; the market is watched for rises and falls after elections or announcements of key appointments, after policy changes, and so forth, presumably reflecting investor confidence in response to the events of the world and their perceived consequences.
World Stock Exchanges
The 20 largest exchanges in the world (roughly in order, though jostling may occur) are as follows:
- NYSE Euronext, formed in 2007 by a merger between the New York Stock Exchange and the European multinational exchange Euronext. The new company also operates the American Stock Exchange (acquired in 2008) and NYSE Arca (formerly the Pacific Exchange, and still located in San Francisco).
- The Tokyo Stock Exchange, which has lately been developing joint products with the London Stock Exchange (LSE), one of which will be a Tokyo market based on the LSE’s less-regulated Alternative Investment Market.
- BM&F Bovespa, formed in 2008 by the merger of the Brazilian Mercantile and Futures Exchange with the São Paulo Stock Exchange. Though slower to adopt electronic systems than many North American exchanges, Bovespa adopted them more decisively: open outcry is long abandoned, and the exchange uses electronic trading exclusively.
- NASDAQ, the National Association of Securities Dealers Automated Quotations, an American exchange and the world’s first electronic stock exchange.
- The London Stock Exchange, the center of “the City” that is the United Kingdom’s equivalent of Wall Street. After NASDAQ failed in an attempt to acquire the LSE, it sold most of its shares—28 percent of the company—to the Borse Dubai in the United Arab Emirates.
- The Hong Kong Stock Exchange, the largest exchange in China.
- The Shanghai Stock Exchange, the largest exchange in mainland China.
- The Toronto Stock Exchange, the largest Canadian exchange, with the most oil and mining stocks in the world. The TSX is Canada’s only exchange for preferred stock; common stock is handled by the Canadian Venture Exchange, and derivatives by the Montreal Exchange.
- The Frankfurt Stock Exchange, owned and operated by the Deutsche Borse, which attempted to negotiate a merger with Euronext before the NYSE beat its offer.
- The Madrid Stock Exchange, Spain’s largest exchange.
- The Bombay Stock Exchange, the largest exchange in south Asia, listing more companies than any other exchange in the world.
- The National Stock Exchange of India, one of the fastest-growing exchanges in the world.
- The Australian Stock Exchange, an all-electronic exchange that originated in the 19th century as an exchange to trade government-issued securities.
- OMX Exchanges, operating eight exchanges in Scandinavia.
- SWX, the Swiss exchange in Zurich.
- Korea Exchange, formed by the merger of the Korea Stock Exchange, KOSDAQ, and the Korea Futures Exchange.
- Borsa Italiana, in Milan, owned by the LSE.
- The Moscow Interback Currency Exchange (MICEX), responsible for 90 percent of the trading in Russia.
- The JSE Securities Exchange, in Johannesburg, the largest exchange in Africa.
- The Shenzhen Stock Exchange, mainland China’s second-largest exchange.
Indices
A stock market index tracks the performance of a section of the stock market, to various ends. There are various kinds of indices, but most indices are specific to a given exchange. Significant indices include the Dow Jones Industrial Average, or just “the Dow,” an unweighted index tracking 30 stocks on the NYSE. The oldest such index in the world, the Dow is also the one most discussed as an economic indicator. The companies it lists are the giants of American industry, from Kraft Foods and McDonald’s to ExxonMobil and Wal-Mart. The Dow is not maintained by the NYSE, but by the editors of the Wall Street Journal. The NYSE maintains the NYSE Composite Index, tracking over 2,000 stocks using free-float market cap weighting (in which the largest stocks impact the index the most).
The S&P 500 is another capitalization-weighted index, tracking 500 stocks (generally, those with the largest market capitalization) on the NYSE and NASDAQ. The FTSE Index, begun as a joint venture between the LSE and the Financial Times, is the leading indicator for the London market—tracking 80 percent of the market capitalization on the LSE, in a free-float market cap weighted index like the NYSE Composite. Most exchanges have an index tracking their top performers, prominent companies, or a large portion of the market; but there are indices designed along other lines as well. The Calvert Social Index, for instance, is a capitalization-weighted index tracking the most socially responsible companies on the market.
The Trading Floor
The trading floor of a stock exchange is where most trades occur. There is often, especially in older exchanges, a designated area for each stock on the exchange; on the floor of the NYSE, for instance, is a podium or desk for each of the 3,000 companies listed, and transactions are conducted face to face. A trading room, on the other hand—though traders at some exchanges use the phrase to mean the trading floor—is the office or set of offices set aside in a brokerage or investment bank for trading activity. In large firms, the trading room is often enormous; those of J. P. Morgan are so large that the six floors of trading rooms had to be cantilevered because they exceeded the footprint of the building itself. Trading rooms are filled with desks and phones for traders, and a good deal of expensive equipment for monitoring the markets both domestically and abroad.
Many trading floors use the open outcry system of communication between traders, an artifact of forward to indicate that the order has not been filled yet but the trader is working on it (the open outcry equivalent of the hourglass icon in Windows); and the hand across the throat to cancel an order or show that an order has been cancelled. In most American exchanges, the part of the trading floor where open outcry takes place is called the pit, for its sloped sides, which make it easier for traders to see each other. the pre-electronics age that persists on the major exchanges of North America and the United Kingdom. Open outcry uses a combination of shouting and hand signals to communicate orders from across the room or over a crowd. Hands away from the body, palms out, indicate a seller; hands up, palms in, indicate a prospective buyer. One hand is used to indicate the numbers one through 10 (six through 10 are indicated by holding the hand at a 90-degree angle), while the other hand indicates tens, hundreds, or thousands depending on its position. There are signals to indicate time frames of a trade, combination trades, options, and other information. Specifics vary some from exchange to exchange, but other near-universal signals include the thumbs-up to indicate that an order has been filled; an index finger, tilted, rotating
Electronic Trading
Electronic trading systems have replaced open outcry in many markets. One of the first was CATS, the Computer-Assisted Trading System, which was adopted at the Toronto Stock Exchange in 1977 and implemented at various exchanges throughout the 1980s, sometimes supplementing open outcry and sometimes replacing it. NASDAQ—the National Association of Securities Dealers Automated Quotations—originated as a computer bulletin board system in 1971, long before home internet access or even home computers were commonplace; originally it was not used to actually broker trades, but did lower the spread between the asking and bidding prices.
As NASDAQ developed into the first electronic stock exchange, it added the ability to make trades over the phone, and advertised itself directly to the public, the first exchange to do so. At the end of 1988, addressing complaints that stockholders had trouble reaching market makers on the phone in the wake of 1987’s Black Monday market crash, NASDAQ adopted the Small Order Execution System (SOES), an electronic trading system for low-volume trades. Like NASDAQ itself, SOES was resented by many brokerage houses for—in general—reducing their profit margin on many transactions. NASDAQ would argue that this was offset by such systems attracting investors who might not otherwise enter the market.
Ten years later, in 1998, the SEC authorized the creation of electronic communication networks (ECNs) in response to the popularity of the internet and increasing ubiquity of home computers. ECNs facilitate trades outside stock exchanges, as a class of Alternative Trading Systems. Soon a number of electronic systems were being adopted to conduct trading at the exchange, rather than leaving the business of electronic trading to ECNs that bypass them. Retail brokers like Charles Schwab went online en masse in the late 1990s and turn of the century, offering e-trading options, often with significantly lower fees than more traditional services had charged. Automating more aspects of the trading process has brought transaction costs down, though many old-school traders resist the move away from open outcry because of the loss of the intangibles involved in the transaction; when you can see the other party, you can read body language and gauge the motivation of the trade.
Some exchanges have software for e-trading; others license software from a third-party provider. The development of e-trading software is quickly becoming a niche field in the computer software industry, and traders who deal with multiple exchanges find themselves required to stay on the technological cutting edge. One development, a case in which e-trading does much more than simply allow trades without face-to-face contact, is algorithmic trading. Sometimes called robo-trading or black-box trading, algorithmic trading relies on mathematical algorithms to determine one or more aspects of a trade—from the acceptable bid or ask price to the timing or size of the trade, and especially the relationship of those aspects to one another (buying more shares of a stock at a good price, for instance). On the one hand, it is the sort of decision making a human agent could do, using the same underlying logic; on the other hand, once such decisions are reduced mathematically, the process transpires much faster, allowing opportunities to be captured before the window closes.
By 2006 a third of stock trades made in Europe and North America were conducted algorithmically; the popularity of the software continues to steadily rise. Algorithmic trading is also popular, if slightly less so, on the futures, options, and foreign currency markets. Different common algorithms have developed, including the Guerrilla algorithm developed by Credit Suisse, which determines in real time which available offers or bids can be accepted without disrupting the stock’s trading pattern. Another Credit Suisse algorithm, Sniper, is designed to detect “dark pools of liquidity,” not shown on the trading platforms provided by stock exchanges as a result of algorithmic trading performed by other parties. Snipers are sophisticated algorithms, useful only in an environment where a significant amount of algorithmic trading is going on—and they are not the only one of their type. Sniffer algorithms are designed specifically to detect and identify trading algorithms in use, while
Bespoke algorithms cloak algorithmic activity. The prevalence of electronic trading has led some to predict, plan, or hope for an online-only stock exchange.
Listing Requirements
Stock exchanges typically have certain requirements for companies that want to have their stock listed on the exchange. These requirements can include the minimum annual income, minimum shares outstanding, and minimum market capitalization. The NYSE requires that a company have at least one million shares of stock, that the total shares be worth at least $100 million, and that the company has earned at least $10 million over the last three years. NASDAQ requires 1.25 million shares, worth $70 million, and $11 million in three years of earnings. The London Stock Exchange has a different set of requirements entirely—12 months of working capital, three years of audited financial statements, 25 percent public float, and 700,000 pounds market capitalization.
Bibliography:
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- Tokic and S. Tokic, “Time to Leave Foreign Stock Markets?” Journal of Corporate Accounting and Finance (v.19/6 2008).
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