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How do stock exchanges work

Find out how stock exchanges work, plus how they protect investors and help companies raise finance.

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By

Alice Guy

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We’ve all seen the movies: traders shouting instructions across a noisy stock exchange trading floor. But how do stock exchanges work in real life? How do they benefit investors and why do companies use them to list their shares?

In this guide, we take a look at everything you need to know about stock exchanges. We also answer common questions like “what’s the difference between a stock market and a stock exchange?” and “what are the main stock exchanges?”

What is a stock exchange?

A stock exchange is a marketplace for shares and other financial instruments like bonds and commodities. There are major stock exchanges all around the world, including the London Stock Exchange, the New York Stock Exchange, the Nasdaq and the Shanghai Stock Exchange.

Stock exchanges make it easier for companies to raise finance as they have a ready place to sell their shares. They also provide easy access for investors to find out information on shares and buy and sell shares or other financial assets through their broker. Stock exchanges ensure that buyers and sellers can trade efficiently, without unnecessary delays.

The stock exchange doesn’t actually own shares but provides somewhere that companies can list their shares, ready for sale and purchase. Companies that want to list their shares on a stock exchange will need to meet the listing requirements set by that stock exchange. These listing requirements are designed to protect investors and make sure that the listed companies meet certain standards.

What’s the difference between a stock market and a stock exchange?

A stock market is a broad term describing how stocks can be bought and sold across various platforms, including stock exchanges. Some investors choose to invest in startup companies or buy unlisted shares that aren’t yet listed on any stock exchange.

A stock exchange is part of the stock market. It’s a particular market for listed shares, which tend to be the shares of bigger companies. Stock exchanges regulate listed companies and allow investors to track share prices, trading volumes and market cap (the total market value of listed companies).

An exchange can be an actual physical space or a virtual space where traders can buy and sell online.

How do stock exchanges work?

A stock exchange provides a physical or virtual marketplace for investors and traders. It makes sure that fair rules are in place and that investors are provided with up-to-date share price information. Stock exchanges each have their own listing rules, which companies must comply with before their shares are listed.

The first public listing of a new company on a stock exchange is called an initial public offering (IPO). In the UK, a company listing on the London Stock Exchange has to meet a set of standards set by the Financial Conduct Authority (FCA).

In the UK, the London Stock Exchange lists most of the largest UK companies. Investors who want to buy or sell shares have to go through a broker who is licensed by the exchange. You can buy or sell these shares through a share dealing platform. Some pension schemes and stocks and shares ISA also let you buy individual shares.

Why do stock exchanges exist?

Stock exchanges exist to make it easier for buyers and sellers to trade. Rules and standards make sure that there is fair trading and that listed companies comply with certain standards. This reduces the risk for investors and ensures that price information is transparent and accurate.

Here is a summary of some of the main functions and benefits of stock exchanges:

  • Determining a fair price – shares are traded publicly and the share price is visible for all investors.
  • Protecting investors’ interests – stock exchanges set regulations and make sure companies comply with their standards.
  • Acting as secondary markets – investors can sell certain assets, like bonds, during the lock-in period when they couldn’t normally sell them.
  • Making it easier for companies to raise finance – companies can get funding to help them expand by listing or by issuing more shares.
  • Promoting overall economic wealth in a country – investors can get access to investing and companies can raise a larger amount of finance through a public listing.
  • Reducing the need for business debt – companies can raise finance more easily through selling shares and may not have to take on debt. This helps them grow more quickly and frees up profit that would have to be spent on interest payments.

How to find a stock exchange?

If you’re an ordinary investor, you don’t need to worry about finding a stock exchange to buy and sell shares. You won’t be allowed to buy and sell directly on the stock exchange but will need to use a broker. In the UK, you can use a share dealing account. Some pension schemes and stocks and shares ISAs also allow you to invest in individual shares.

What are the main stock exchanges?

Many countries around the world have at least one major exchange. Here are the top 10 exchanges in the world together with their respective market cap, which is the total value of shares listed on their stock exchange.

Stock exchangeLocationMarket cap ($ trillion value) based on 2020/21 data
1New York Stock ExchangeNew York, US26.64
2NasdaqNew York, US23.46
3Shanghai Stock ExchangeShanghai, China7.63
4EuronextVarious locations, Europe7.33
5Japan Exchange GroupTokyo & Osaka, Japan6.79
6Hong Kong Stock ExchangeHong Kong6.13
7Shenzhen Stock ExchangeShenzhen, China5.74
8London Stock ExchangeLondon, United Kingdom4.05
9Bombay Stock ExchangeMumbai, India3.96
10National Stock ExchangeMumbai, India3.77

How do stock exchanges make money?

Stock exchanges earn money by charging listing fees to new and existing companies listed on their stock exchange.

On the London Stock Exchange, the basic admission costs are between £700,000 and £900,000. In addition, newly listed companies have to pay brokers’ fees to raise funds, which may be around 4% to 6% of the total funds raised. Once a company is listed, it will have to pay annual stock exchange fees based on its market capitalisation (the total value of its shares).

What stock exchange can I use?

Ordinary investors can’t use a stock exchange directly as only licensed traders are allowed to trade. If you want to buy or sell shares, you’ll need to use a stockbroker with permission to buy and sell on the exchange.

However, stock exchange websites are still useful for private investors to check out possible investments. You’ll be able to get the lowdown on a company’s market capitalisation and its share price history as well as a summary of its activities.

How did the London Stock Exchange start?

Zoe Stabler

Finder expert Zoe Stabler answers

Did you know that the London Stock Exchange originally started in a coffee shop in 1698 when traders were thrown out of the Royal Exchange for being too rowdy? John Castaing published a list of currency, stock and commodity prices at Jonathan’s Coffee House and traders started visiting to buy and sell shares.

Today, despite more flashy surroundings, the basics of stock exchanges are much the same. Stock exchanges post prices for shares, commodities and bonds and provide a marketplace for buyers and sellers.

Thankfully, ordinary investors don’t have to travel into London and brave the noisy trading floor. We can use a share dealing account, pension or stocks and shares ISA to buy and sell shares.

Bottom line

Established stock exchanges like the London Stock Exchange benefit investors and companies. They provide public information on share prices, market capitalisation and trading volumes. They also regulate listed companies and make sure they comply with the stock exchange rules.

For companies, stock exchanges offer a way to raise a large amount of finance through issuing shares. They can afford to expand without taking on a large amount of expensive debt.

Frequently asked questions

  1. Investopedia
  2. Fool
  3. Withers

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