Tuesday, November 6, 2007

A stock market

A stock market is a market for the trading of company stock, and derivatives of same; both of these are

securities listed on a stock exchange as well as those only traded privately.


The Definition

Trading

Participants in the stock market range from small individual stock investors to large hedge fund

traders, who can be based anywhere. Their orders usually end up with a professional at a stock exchange,

who executes the order.

Some exchanges are physical locations where transactions are carried out on a trading floor, by a method

known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where

traders may enter "verbal" bids and offers simultaneously. The other type of exchange is a virtual kind,

composed of a network of computers where trades are made electronically via traders at computer

terminals.

Actual trades are based on an auction market paradigm where a potential buyer bids a specific price for

a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means

you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices

match, a sale takes place on a first come first served basis if there are multiple bidders or askers at

a given price.

The term 'the stock market' is a concept for the mechanism that enables the trading of company stocks

(collective shares), other securities, and derivatives. Bonds are still traditionally traded in an

informal, over-the-counter market known as the bond market. Commodities are traded in commodities

markets, and derivatives are traded in a variety of markets (but, like bonds, mostly 'over-the-

counter').

The size of the worldwide 'bond market' is estimated at $45 trillion. The size of the 'stock market' is

estimated at about $51 trillion. The world derivatives market has been estimated at about $480 trillion

'face' or nominal value, 30 times the size of the U.S. economy…and 12 times the size of the entire world

economy.[1] The major U.S. Banks alone are said to account for well over $200 trillion. It must be noted

though that the value of the derivatives market, because it is stated in terms of notional values,

cannot be directly compared to a stock or a fixed income security, which traditionally refers to an

actual value. (Many such relatively illiquid securities are valued as marked to model, rather than an

actual market price.)

The stocks are listed and traded on stock exchanges which are entities (a corporation or mutual

organization) specialized in the business of bringing buyers and sellers of stocks and securities

together. The stock market in the United States includes the trading of all securities listed on the

NYSE, the NASDAQ, the Amex, as well as on the many regional exchanges, the OTCBB, and Pink Sheets.

European examples of stock exchanges include the Paris Bourse (now part of Euronext), the London Stock

Exchange and the Deutsche Börse.


The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers,

thus providing a marketplace (virtual or real). The exchanges provide real-time trading information on

the listed securities, facilitating price discovery.

The New York Stock Exchange is a physical exchange. This is also referred to as a "listed" exchange

(because only stocks listed with the exchange may be traded). Orders enter by way of brokerage firms

that are members of the exchange and flow down to floor brokers who go to a specific spot on the floor

where the stock trades. At this location, known as the trading post, there is a specific person known as

the specialist whose job is to match buy orders and sell orders. Prices are determined using an auction

method known as "open outcry": the current bid price is the highest amount any buyer is willing to pay

and the current ask price is the lowest price at which someone is willing to sell; if there is a spread,

no trade takes place. For a trade to take place, there must be a matching bid and ask price. (If a

spread exists, the specialist is supposed to use his own resources of money or stock to close the

difference, after some time.) Once a trade has been made, the details are reported on the "tape" and

sent back to the brokerage firm, who then notifies the investor who placed the order. Although there is

a significant amount of direct human contact in this process, computers do play a huge role in the

process, especially for so-called "program trading".

The Nasdaq is a virtual (listed) exchange, where all of the trading is done over a computer network. The

process is similar to the above, in that the seller provides an asking price and the buyer provides a

bidding price. However, buyers and sellers are electronically matched. One or more Nasdaq market makers

will always provide a bid and ask price at which they will always purchase or sell 'their' stock.[2].

The Paris Bourse, now part of Euronext is an order-driven, electronic stock exchange. It was automated

in the late 1980s. Before, it consisted of an open outcry exchange. Stockbrokers met in the trading

floor or the Palais Brongniart. In 1986, the CATS trading system was introduced, and the order matching

process was fully automated.

From time to time, active trading (especially in large blocks of securities) have moved away from the

'active' exchanges. Securities firms, led by UBS AG, Goldman Sachs Group Inc. and Credit Suisse Group,

already steer 12 percent of U.S. security trades away from the exchanges to their internal systems. That

share probably will increase to 18 percent by 2010 as more investment banks bypass the NYSE and Nasdaq

and pair buyers and sellers of securities themselves, according to data compiled by Boston-based Aite

Group LLC, a brokerage-industry consultant.

Now that computers have eliminated the need for trading floors like the Big Board's, the balance of

power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks

of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11

billion a year that institutional investors pay in trading commissions.

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