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Exchanges

Introduction

The exchanges are the places where buyers and sellers of securities (stocks, bonds, options and futures) come together to make trades. The main focus of this section will be the stock exchanges. They are the mechanisms used by investors to exchange investment securities. Companies use the exchanges when they raise money by selling shares, or when they repurchase shares. The stock exchanges are also popular vehicles used by company owners to raise cash by selling shares (to cash out). Stock exchanges connect buyers with sellers, and ensure that transactions are safe and secure. Prices, in most cases, are determined by the buyers and sellers, not the exchanges. The operations of most industrial organizations are not affected by the secondary trading of shares. The trading of shares by company owners usually has no physical impact on an organization, unless control is affected.

Global competition and technology improvements have been changing the way the exchanges operate. In the United States, the NYSE is the dominant exchange, even though it uses a “people intensive” auction system. It merged with Archipelago’s automated trading platform, to better compete against NASDAQ and other electronic communication networks (ECNs). Computers can now handle the matching of orders faster and cheaper than the existing manual auction system. Investors also prefer the control over their trades that automation provides. The NYSE, therefore, is under competitive pressure to automate, to maintain and grow its worldwide listing and trading leadership position. The NYSE operates with a major physical presence on Wall Street, while NASDAQ and the other ECNs conduct trades through a network of computers around the country.

Automation of the NYSE may have the following effects:

The physical NYSE building will probably, in the future, evolve into a museum and tourist attraction.  As computers take over more and more functions, the trading floor may become obsolete. The open outcry system, where floor brokers shout out prices, will be missed.

The Floor Traders traditionally execute trades on behalf of their clients by matching buyers with sellers. Their positions will most likely be eliminated as automation progresses.  Computers will reduce the need for people to match buyers with sellers, as is done on NASDAQ.

The Specialist work to maintain a fair and orderly market; they do so by providing liquidity and managing prices. They set opening prices and provide bid and ask quotes to brokers throughout the day. If needed, they use their own capital to balance out order flow distortions, in order to maintain an orderly market. They also trade on their own account. The specialists under the "old" NYSE will evolve into market makers of the "new" NYSE.

Market Makers are broker-dealers who work with NASDAQ and specialize in specific stocks. There are multiple market makers for every stock, who are obligated to stand ready to buy or sell at least 100 shares, on a regular and continuous basis, at a publicly quoted price. They are also required to provide two-sided quotes; bid and ask prices that they will honor. Market makers hold an inventory of a particular stock, and provide it to the market as needed. To help offset the market risk of buying high and selling low, they make a spread, which is the difference between the bid and the ask price. Take that spread of a few pennies, and multiply it by the shares traded, and you can conclude that these players make significant money.

The Day Traders are the ones who will see and feel the differences in exchanges similar to those that young adults will see. They look to profit from pennies. The stocks that trade on the NYSE are watched over by specialists, who manage prices. They set the opening prices, and try to keep price swings to a minimum. This makes it hard for day traders to make a quick gain. However, because NASDAQ is automated, it has no specialists keeping prices in line. It uses market makers to provide order by their bid and ask quotes. NASDAQ stocks have larger daily price swings, creating more opportunities for traders and investors alike. The greater price volatility of NASDAQ securities versus NYSE securities is believed to be due to the smaller and less mature companies found on NASDAQ. Nonetheless, by automating the NYSE, it will speed up trading time and reduce cost, but it may increase price volatility, which can be profitable to traders. Order flow and emotions can more easily move prices. News becomes important, because small price movements equate to money for day traders.

There are exchanges all over the world. Global competition is taking its toll on the United States stock exchanges. Recently, most of the large billion dollar plus capital raising deals have been done outside of the United States. The regulatory environment, in the United States, is just to harsh. The US stock exchanges are looking to develop new products and expand globally to maintain their customers.

In the United States there are the major exchanges and several smaller regional exchanges.

The Major Stock Exchanges Are:

The New York Stock Exchange (NYSE)  Founded in 1792, it is commonly known as “The Big Board”. It is the largest exchange in the world for the listing and trading of securities. The NYSE lists approximately 2,800 companies, with a total market capitalization of over $20 trillion. On an average day, 1.6 billion shares, valued at $56 billion, are traded. Trading starts at 9:30 a.m. and closes at 4 p.m. There are, however, overtime opportunities with extended hours.  This is the place where executives and heads of state want to have a photo opportunity, ringing the opening bell of the exchange. Companies listed on the exchange have to meet certain size (listing) requirements to substantiate that they are successful organizations, with the financial resources deserving secondary markets where their shares can trade. The NYSE still uses floor traders to make trades. Its merger with Archipelago is expected to more fully automate their processes, and transform them into a publicly traded for-profit company. The NYSE is also looking to expand overseas.  

The American Stock Exchange (AMEX)  Founded in 1849, it today lists over 600, mostly smaller and younger midsize growth, companies. Trading hours are from 9:30 a.m. to 4 p.m. Many exchange-traded funds, derivatives and bonds are traded on the AMEX. Listing requirements are favorable to smaller companies that don’t qualify for the NYSE. The majority of AMEX’s trading volume and growth is derived from exchange-traded funds.

NASDAQ  Founded in 1971, it is the largest of the automated computerized trading platforms, and lists over 3,200 companies. NASDAQ Merged with AMEX in 1998 and is now exploring global opportunities.

Electronic Communication Networks (ECNs)   These are companies with customer friendly, computerized systems that automatically match customer orders. They are generating significant volume, and threatening the existing exchanges. Archipelago and Instinet were ECNs. ECNs are growing quickly because their fee structures are less than the bid/ask spreads that are charged by the market makers. There is always a market for low cost alternatives and the ECNs are filling that niche.       

The Chicago Board Options Exchange (CBOE)  Founded in 1973 by the Chicago Board of Trade, with the intent to standardize and trade public option contracts. Today, CBOE is the largest option exchange in the world.        

The New York Mercantile Exchange (NYMEX)  Founded in 1872 as the Butter and Cheese Exchange of New York; added fruit and poultry contracts 10 years later and changed its name to NYMEX. Today NYMEX is the world’s largest physical commodity future exchange and a preeminent trading forum for energy and precious metals.    

Chicago Mercantile Exchange (CME)  Founded in 1898 as the Chicago Butter and Egg Board; changed its name to CME in 1919. Today, CME is the second largest exchange for futures, and options on futures, in the world.    

There are also a few regional stock exchanges in the United States, as well as major exchanges in many foreign cities 

Regulators

The SEC regulates the exchanges in the United States.

 

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