Investing in Stocks? Understand the Exchanges

The stock exchange adds crucial efficiency to the interaction among businesses, investors, and brokers. Without it, businesses couldn't raise as much capital, investors wouldn't know the value of their holdings and the stockbroker's job would be much harder.

"Come on in, the water's fine!" Surely you've heard this advice before, only to find yourself doing a cannonball into a pool of ice water. Having learned your lesson, you're smart to test the waters before leaping in. If you're considering stock market investing, that testing process might include a quick course on what the stock market is, and how it works.

Online auction sites and the stock exchange

Everyday, thousands of purchases and sales are transacted on eBay and other online auction sites. These sites are places where people congregate, in a virtual way, to buy and sell their stuff. Sellers know that listing their goods on eBay provides them with more exposure than they could get otherwise. Buyers know that a few quick searches will reveal whether the wanted item can be found anywhere on eBay's vast merchant network.

Stock exchanges function in a similar fashion; they're the places where stock sellers and buyers come together to trade dollars for investments. There are three primary parties doing business on the stock exchange:

The entity issuing stocks, bonds or other securities. Most often, this is a corporation selling stocks or bonds to raise capital. Corporations and other entities must register their securities with the exchange. Each exchange has its own registration requirements, usually pertaining to the entity's size and financial strength.

The stockbroker. The stockbroker initiates stock trades on behalf of his customer, the investor.

The investor. The investor provides the money that funds the stock trade.

The world's largest stock exchanges are the New York Stock Exchange or NYSE, the Tokyo Stock Exchange, and the NASDAQ.

Efficient for business, efficient for investors

Having one centralized forum for stock trading benefits businesses and investors. Businesses sell shares of stock to raise capital. If there was no exchange, the business would have to find suitable investors and then transact the stock sales on their own. Then, when the investors wanted to sell those shares to someone else, they'd have to find another investor, negotiate a price, and transact the sale.

With centralized trading, businesses and investors can buy or sell their holdings immediately. There's no price negotiation because investors have the choice of buying, selling, or holding investments at the current trading prices. These trade decisions are based on the perceived market value of the stock. In the simplest terms, investors buy when they think the stock will increase in value over time. They sell when they believe the stock will decrease in value.

You've just placed your big toe into the backyard pool of stock market investing. Before you know it, you'll be treading water with your own diversified portfolio.