A stock exchange is a marketplace where the securities of listed companies, such as stocks and bonds, can be bought and sold by investors as well as traders. The stock market consists of many exchanges around the world.

In the United Kingdom, the primary exchange is the London Stock Exchange. The New York Stock Exchange and Nasdaq Exchange are where most trading activity happens in the United States.

Companies use exchanges to issue debt and equity securities. That way, public investors can instantly find, purchase, or sell these securities almost anywhere in the world.

For businesses, it exists as one of many methods to raise external capital. For investors, it serves as an easy method to invest money under the protection of regulation to try and build personal or client wealth.

How does a stock exchange work?

Films and TV shows often portray the trading floor in exchange to be a bunch of people crammed into a room shouting orders and hand gestures at each other. This is more commonly referred to as open outcry and was certainly the case until the late 1980s.

Since then, the stock market has become increasingly digitalised, with trading optimised to be executed over the internet. There are still some floor traders working in the pits of stock exchanges. However, they typically only handle large-scale trades and special situations. Everything else almost always gets passed through an automated electronic trading platform.

This evolution of technology has not only made investing more efficient but has also drastically reduced costs. In fact, most brokerage accounts today offer commission-free trading.

What is the purpose of a stock exchange?

As previously mentioned, the stock exchange serves several vital roles beyond being a marketplace for investors and traders.

• Raising Capital – A listed company on an established stock exchange instantly gains access to a pool of millions of investors that can be leveraged to raise money for projects, acquisitions, or general operation expansion.
• Create Opportunities – Investors can buy and sell listed shares or debt instruments to grow their wealth over time in a regulated marketplace with protections against fraud.

Advantages of being a listed business

As a business, a lot of prestige comes from being listed on a stock exchange. Becoming a publically traded company is not an easy process with strict requirements in place. With the financials and other critical pieces of information being publically available, securing new financing solutions can also become cheaper and easier to access. Not to mention the additional visibility it gives to a business and its brand.

Disadvantages of being a listed business

There are, of course, some drawbacks to becoming a publicly traded company. Most notable is the cost. Becoming a listed company on an exchange can be costly, sometimes costing millions during the initial public offering (IPO) stage.

Firms also need to pay recurring fees and maintain a minimum trading volume. The latter usually involves spending money to attract institutional investors and mutual funds to invest in the business. Furthermore, companies must also cover the additional accounting and legal costs of preparing and submitting required regulatory documents and hosting investor events.

Beyond cost considerations, companies also have to deal with stock market volatility. It’s in a business’s interest to raise its stock price as high as possible, as this creates opportunities to raise additional capital in the future. However, volatility, especially during periods of economic turbulence, can drag share prices down considerably. During these periods, issuing new shares isn’t an effective means of raising money.

What are the 4 types of stock exchanges?

There are four primary types of stock exchanges. And while they all serve the same purpose, there are differences in how they operate, making them suitable under different conditions.

• Auction Markets – In an auction market exchange, buyers and sellers are matched based on the prices a buy and seller are willing to accept. The buyer is looking for the lowest possible price, while the seller is after the highest. The two parties “negotiate” in an automated bidding process until a match is found and the trade is executed. With hundreds of thousands of trades moving through an exchange every second, these deals are completed almost instantly. This is how the London Stock Exchange and New York Stock Exchange work.
• Electronic Communication Networks (ECNs) – ECNs are a special exchange type listed as an Alternative Trading System (ATS) that must be registered with regulators. An investor needs to be a member to use this type of exchange. However, membership is often reserved for financial institutions, brokers, and high-net-worth clients. Executing buy and sell orders through an ECN is more expensive but enables transactions to be completed outside of regular trading hours when the major exchanges are closed. One of the most popular ECNs in the United States is Bloomberg Tradebook.
• Electronic Trading – This is arguably one of the most commonly used methods to execute trades today. Investors use an online trading platform that is connected to an auction market exchange or electronic communications network to complete orders.
• Over-the-Counter (OTC) – An OTC exchange is where smaller companies typically reside. To join a main exchange, businesses must meet certain requirements, including a minimum size. An OTC exchange serves as a method for small businesses to still become publically traded even if they don’t meet the size criteria of the main exchanges. OTC-listed stocks are also held to less strict regulatory reporting standards, making fraud more common than on a primary exchange. Stocks listed on the OTC markets still require a broker to buy and sell. However, the trading fees are typically higher due to the reduced trading volume.

What is a dark pool?

Just like an electronic communications network, a dark pool is another type of alternative trading system registered with regulators. It’s effectively equivalent to a stock exchange. However, a key difference is that it’s not open to the public.

Dark pools are private financial forums for trading various types of securities anonymously. Investors can place orders to buy or sell shares without the transactions being reported until after they are completed. This can be an essential requirement for investors or companies seeking to acquire a stake in an acquisition target for a friendly or hostile takeover without influencing the share price beforehand.

Dark pools provide increased market liquidity resulting in more efficient investing operations. However, their lack of transparency draws a lot of criticism. And they are known for hiding conflicts of interest as well as creating opportunities for predatory trading practices.

How does the stock exchange make money?

A stock exchange typically has four primary revenue channels.

1. Listing Fees – The exchange charges businesses an initial admission fee followed by recurring annual listing fees to have their shares traded. These fees are dependent on the size of a business. In 2023 the minimum admission fee for the London Stock Exchange stands at £14,805. For a £1bn company going public, the admission fee is approximately £421,635.
2. Data Fees – The bulk of a stock exchange’s revenue stems from its data services. In exchange for a very expensive annual fee, hedge funds and financial institutions can gain access to accurate time trading data moving through the stock market without the 15-minute delay from free online stock quoting websites like Yahoo Finance. For long-term investors, real-time data is less valuable. But for short-term traders, it’s essential to stay ahead of the pack.
3. Software Licensing – Some exchanges offer proprietary trading software that can be used with their real-time data services. Licenses are often sold on an annual or quarterly basis.
4. Transaction Fees – Lastly, exchanges charge a tiny transaction fee on trades that get baked into the bid-ask spread. This is so minute that most investors won’t even realise it’s happening. But when scaled up across millions of shares traded daily, it can be a lucrative source of income.

What are the major UK stock exchanges?

The United Kingdom is home to many stock exchanges that many retail investors aren’t even aware of.

• London Stock Exchange – The largest stock exchange in Europe and one of the most liquid investing pools in the world. It provides a platform for companies to raise capital and for investors to build their portfolios across various global markets.
• Alternative Investment Market (AIM) – This is a subsection of the London Stock Exchange and contains all the small-cap companies that don’t meet the size requirements to be listed on the main market.
• ICAP Securities and Derivative Exchange – This is a secondary market for both listed and unlisted companies. It trades securities by offering brokerage and execution services.
• London Metal Exchange – This exchange offers contracts for ferrous and precious metals. 
• Chi-X – This is a trading platform for European securities.
• Intercontinental Exchange – This is a digital exchange that creates connections for global opportunities for investors.  
• The Baltic Exchange – A source of maritime market information. It arranges ocean transport and bulk flight. 
• The Social Stock Exchange – This exchange lists non-profit organisations on a stock exchange. 

What are the major US stock exchanges?

Like the UK, many stock exchanges based in the United States each serve a slightly different role.

• New York Stock Exchange – This is a major stock exchange in the US. They provide a platform where companies can raise capital. It is one of the largest stock exchanges in the world by market cap.
• Nasdaq – This is a stock market that provides financial services to both investors and companies.
• Boston Stock Exchange – Provides financial advisory services to its investors and access to the world financial market and investments.
• Chicago Mercantile Exchange – A trading hub for precious metals, foreign currencies, treasury bonds and many kinds of derivatives.
• International Securities Exchange – Provides a fully electronic options exchange. 

The Bottom line

Stock exchanges are an essential medium for both investors and companies. It helps businesses to raise funds for their operations and expansions while also creating wealth for individual investors. Existing shareholders equally transact with potential buyers to sell all or parts of their holding as they want. 

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.