13.08.2018

How does the stock exchange actually work?

Stock exchanges play a key role in the financial market and economy. They are also crucial for you as an investor. We explain how the stock exchange works.

A stock exchange is essentially like a marketplace – buyers and sellers come together to trade commodities or securities. The stock exchange is extremely important for investors. It is where they trade securities and where companies raise capital. There are two different types of market: the primary market and the secondary market.

Primary market: companies raise capital

Companies raise money on the primary market. They issue shares or bonds which are bought by investors. In the case of shares, companies usually raise equity on the market through a stock market flotation or capital increase. If companies issue bonds, they raise debt capital.

Here is an infographic that explains how the stock exchange works. There is an icon at the bottom which symbolizes the company. A second icon next to it symbolizes the investor. An arrow points from the company to a grey rectangle symbolizing the stock exchange. This means that the company is issuing securities. Another arrow points from the investor towards the stock exchange. This means that the investor is investing money. In the stock exchange. The investor’s money is exchanged for the company’s securities on the stock exchange. This is represented by a securities icon and an icon depicting notes and coins. The two icons are connected to each other by two arrows pointing in opposite directions.

Secondary market: investors trade securities

Shares and bonds are traded on the secondary market. Their price is determined by the principle of supply and demand. The latter is based on the expectation of future gains. This means the price – in other words, the value of the security – is constantly changing. If lots of traders want to buy a particular share, then its price rises. Conversely, the price falls if many of them want to sell it off. In this case, demand affects the price, as the quantity of the offer remains the same.

Here is a graphic that illustrates how the secondary market works. The rectangle at the top symbolizes the stock exchange. It contains a securities icon and a money icon depicting coins and notes. There are two icons at the bottom that represent investors. One of the investors wants to sell securities. An arrow is pointing upwards from him towards the stock exchange. The other investor wants to purchase securities. There is an arrow pointing down towards him from the stock exchange.

Electronic platforms are ousting floor trading

Private individuals, banks, fund managers but also states, companies and insurance companies can trade on the stock exchange. However, only traders from banks and financial institutions are generally actually present at the stock exchange. They trade according to instructions from their bank or customer.

Many stock market transactions are no longer carried out on the floor, but are instead conducted online. Electronic trading platforms, such as the SIX Swiss Exchange – Switzerland’s biggest exchange – are available for this purpose. In Switzerland, the stock exchanges are monitored by the Swiss Financial Market Supervisory Authority (FINMA). This ensures compliance with legal provisions.

The stock exchange – more than just an intermediary

In short: a stock exchange performs an intermediary role between supply and demand to ensure trade is conducted as efficiently and cost-effectively as possible. It also ensures price transparency. The stock exchange also determines the stock exchange regulations, monitors prices and governs the authorization of traders. Another task of the stock exchange is what’s known as publicity transformation. Investors also receive relevant information about their investments from the issuers of securities due to their obligations to inform, which are governed by the stock exchange. The stock exchange also acts as an economic barometer, as the prices of securities generally depend on economic factors. The stock exchange therefore not only acts as an intermediary but is also an important part of the financial market.

The world’s major stock exchanges

Switzerland’s biggest and most important stock exchange is the SIX Swiss Exchange. It was established in 1995 after the merger of the three stock exchanges in Geneva, Basel and Zurich. The Berne eXchange is a smaller Swiss exchange which specializes in SMEs.

The biggest exchanges in the world by trading volume are:

  • New York Stock Exchange (USA)
  • BATS Global Markets (USA)
  • Nasdaq (USA)
  • Shanghai Stock Exchange (China)
  • Shenzhen Stock Exchange (China)
  • Japan Exchange Group (Japan)
  • Hong Kong Exchanges and Clearing (China)
  • Korea Stock Exchange (South Korea)
  • BATS Chi-x Europe (UK)
  • London Stock Exchange (UK)

This might interest you too