As with all my posts, this is unedited, stream of consciousness stuff that lacks citation. I welcome corrections in the comments.
The last post on stock was on corporations. This time, I’ll go into what the stock market is. When people talk about the stock market, they either generally refer to the stock market as in the global market of people who buy and sell stock or specific stock exchanges where transaction happen and have specific times in which you can buy or sell stock. Usually, it’s a reference towards a specific stock exchange. In order to get a relatively full grasp on what the stock market is, we’re going to have to go back in time a little bit.
What was the stock market like back in the day? Also, a farmers market analogy.
Picture the roaring twenties in the United States. Back then, before computers came along and changed everything, the stock market was actually a physical place. You should understand that shares of stock were represented by stock certificates. These were literally sheets of paper that said you owned X shares of Y company. Furthermore, stock exchanges were physical places where people came to buy or sell stock.
Think of the stock market like a farmers market. In a farmers market, local farmers get together and put their produce on sale. There is no absolute law on what prices must be at a farmers market. Each seller can determine that on their own. However, if your goal is to sell your fruits and vegetables, you are going to want to take a look at your neighbors prices. If he undercuts your prices for the same vegetable at about the same quality, people are going to buy from him rather than you. In this way, everyone at the farmers market is held to this invisible market force which determines the price of what vegetables ought to be. The price and value of produce is determined by the price at which a customer is willing to pay for it. After those purchases occur, the rest of the farmers market can see that and use it as a guide for their pricing.
In the stock market, people who want to buy and sell stock gather in order to buy and sell stock. There are a number of stock exchanges in the world, but for the purposes of this explanation that takes place in the 1920’s, let’s go with the New York Stock Exchange. Back in the day, Wall Street literally referred to a street where people would gather to buy and sell stock. I remember reading about this and looking at photos of guys in suits yelling at each other while hanging off lampposts and screaming out of windows (buildings weren’t yet as tall in Manhattan as they are now). It was organized anarchy. People shouting prices at each with papers in their hands… at least that’s what it looked like from the picture. After a while and likely some rain, these buyers and sellers decided to take the anarchy indoors.
Nowadays, the New York Stock exchange is the literal floor of a building located on Wall Street in New York City. People licensed by the New York Stock Exchange to buy and sell stock (usually on the behalf of others) can go there to buy stock. We don’t really exchange paper stock certificates anymore. Stock brokers generally just keep a record of the transaction and of who owns what.
What was the effect of the internet on stock exchanges?
The internet changed almost everything. Back in the day, buying and selling stock was a physical process that required the transfer a physical pieces of paper. The paper had actual value and helped prove ownership. Since the arrival of the digital age, that whole thing with paper went the way of the dodo. Computers can facilitate millions of transactions around the world at a speed a person could never hope to achieve. Like many jobs, the job of the guy on the stock exchange floor has become mostly obsolete. I think there are still a number of people on the floor, but their jobs are far less chaotic and less like an auctioneer at a flea market as it was in the old days. In fact, they all likely have an awareness that when they move on from those jobs, there is a high likelihood no one will replace them. There’s no point now that we have computers.
What are some technical aspects about stock exchanges?
It’s probably easier to do this through bullet points.
- Even though the internet and computers have made things global and allowed people from around the world to trade on the stock exchange, there are still physical hours that the stock exchange is open. In the case of the New York Stock Exchange, those hours are 9:30 AM to 4:30 PM, Monday through Friday, except for some holidays, and time follows New York City’s time zone.
- Stock exchanges don’t have the stock of every single company in existence in them. You have to have your company listed on the stock exchange. I’m not familiar with the process, but there is a process to get that done.
- Having your company listed on a stock exchange incurs a lot of differences versus that of a privately held company (not traded on a stock exchange). Two changes are that publicly held companies tend to focus more on increasing shareholder value and that there are mandatory disclosures required of that company due to federal law.
- Generally, the companies listed on a stock exchange are of companies from that country. For example, the New York Stock Exchange is the largest stock exchange in the United States of America and, though it doesn’t have all American companies listed, it does generally have all the American companies listed on it that most people know or care about.
- Barring some exceptions, if you want to buy stock in a foreign country, you’re going to have to go to their stock exchange which is in their country. Thanks to the internet, that means just a few clicks through your computer rather than buying a plane ticket and physically going there.
- Not everyone can go to the floor of the exchange nor are they allowed to participate in transactions there. You need to be a member of the exchange in order to get permission to buy or sell stock on that exchange. Members generally aren’t individuals, but financial firms and companies. I don’t know the formalities of becoming a member, but there’s a process.
- Almost everyone who buys/sells stock buys through a broker/member who can buy/sell stock on an exchange. Generally, your average stock purchaser/seller pays a fee per each order made through a broker.
- The New York Stock Exchange is the largest stock exchange in the United States. Like many exchanges, it is a nongovernmental organization. Though stock exchanges/transactions are governed by various laws, the New York Stock Exchange has no expectation to serve the public in the same way the government does. Arguably, this raises various moral/ethical issues like those surrounding high frequency trading.
- On the other hand, the Shanghai Stock Exchange is owned by the government and when there is a conflict between the government’s interests and those of stockholders, it’s not hard to see how the government may force outcomes rather than permitting the market to determine stock prices. This means that prices set in the Shanghai Stock Exchange may be deceptive or inaccurate depending on the level of government interference.
- The stock market acts like a market. That is to say that the price of a given company’s stock changes throughout the day depending on the price being asked and the price being accepted. Because of the internet and the sheer number of transactions going on throughout the day (all of which happen in real-time), the price can change within fractions of a second.
Why do we even have stock exchanges?
The same reason we have farmers markets or supermarkets: convenience. Imagine if there was no centralized place to buy or sell things like stock, or even vegetables or toilet paper. Every time you wanted to buy something you’d have to track down the seller, go all the way to their location — which may be on the other side of the country — all so you could get whatever it is you want.
Imagine wanting to buy a share of X company because you like the company and you think it would be a good investment as the price of that share may rise in the future. Without a stock exchange providing a place for buyers and sellers to meet, how would you figure out who owns shares of X company? The company doesn’t necessarily own a stock pile of its own shares and even if it did, maybe they don’t want to sell you any. Now you have to track down actual owners of that stock (who may all live off the grid in a fallout shelter somewhere) and among those owners, you then have to find one of them willing to sell you some. Exchanges makes it easier for buyers and sellers to connect.
Furthermore, it also helps stabilize the price. Imagine that after weeks of searching, you finally find that one guy who is willing to sell a share of X company. You did some research and find that ten dollars should be a fair price for a share of X company. Instead, he asks for one hundred thousand dollars per share. That sucks.
Like at the farmers market, sellers can undercut each other and buyers can outbid each other, thus raising or lowering the price of whatever is being bought/sold through actual demand. By having all available buyers and sellers in one place, you can easily compare the prices of offers and make decisions accordingly. Someone wants to sell a share at a hundred thousand dollars? That’s fine because there are a hundred other sellers who are willing to sell that share for the more reasonable ten dollars. Nice.
Stock exchanges are facilitators for the most part. They provide a controlled space (though more virtual than physical now because of computers) for stock transactions to take place. That they are nongovernmental organizations raises various issues, though I’m not sure what would be a better alternative.