A stock exchange forms the backbone of a capitalist economy. The first stock exchange in the U.S. dates to 1792, when 24 brokers signed an agreement establishing the guidelines to be followed for trading stocks and bonds. Stock exchanges offer a regulated, organized clearinghouse where companies and governments may sell their securities and investors may purchase them. Although precise rules vary by country, all stock exchanges share certain features.
Consider the chaos that would result if 100 million people attempted to purchase shares from 20 different companies and you can appreciate the advantage of centralizing trades. To make a purchase, the buyer would need to locate a seller, and there is always the risk that either the buyer would not remit the agreed upon price or the seller would fail to surrender the stock certificates. Centralizing trades allows buyers and sellers to connect, and regulations drastically reduce the risk that either will default on the agreement.
Stock exchanges must follow regulations established by regulatory agencies. In the U.S., the Securities and Exchange Commission is the watchdog for publicly traded stocks and bonds. Companies desiring to sell stocks must register and obtain approval from the exchange and comply with all SEC regulations. Brokers must be approved by the exchange to enter orders on behalf of buyers and sellers. Government oversight helps reduce the risk to investors and gives them more confidence in the country's overall economic stability.
The current selling price for each stock is openly stated on a stock exchange, and during the hours that the exchange is open, the price is updated continuously. There are no secret deals, where one investor unfairly receives a better price than another from the company selling the stock or a broker. Instead, buying stock at the best price is a matter of choosing the right time to buy or sell.
If all of a company's shareholders chose to sell all of their stock on the same day, the stock would likely be worthless by the end of the day. Brokers use the term "liquidity" to describe the volume of a stock that may be traded in a short time before its price is impacted. If a stock has high liquidity, that means it is readily available to both buyers and sellers. Exchanges improve a stock's liquidity.
- Stockbyte/Stockbyte/Getty Images