As a new investor, you'll discover that many of your stock trades are going to be placed on one of a handful of stock exchanges. What is a stock exchange? How many major stock exchanges are there in the world? Those are great questions. Let's take a look, so you understand what is a Stock Exchange and how does it work.
First, what is a stock exchange? Put simply, a stock exchange is an institution, organization, or association which hosts a market where stocks, bonds, funds, futures, and commodities are traded. Buyers and sellers come together to trade during specific hours on business days. Stock Exchanges impose rules and regulations on the firms and brokers that are involved with them. If a particular company is traded on a stock exchange, it is referred to as "listed."
Securities that are not listed on a stock exchange are sold OTC, which stands for Over-The-Counter. Companies that have shares traded OTC are usually smaller and riskier because they do not meet the requirements to be listed on a stock exchange. Many giant blue-chip stocks, such as Berkshire Hathaway, at one time traded on the over-the-counter market before migrating to the so-called "Big Board," or New York Stock Exchange.
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When a business raises capital by issuing shares, the owners of those new shares are likely going to want to sell their stake someday. Maybe they have a child going to college and need to cover the tuition bill. Perhaps they pass away, and their estate is subject to some hefty estate taxes. They may even leave it to their grandchildren, who get to enjoy the stepped-up basis loophole, but the heirs want to liquidate to buy a house. Whatever is driving their decision, they aren't likely to tie up their funds unless they know somehow, someway, at some point in the future, they'll be able to find a buyer for their holdings without too much trouble in what is known as "the secondary market."
Without a stock exchange, these owners would have to go around to friends, family members, and community members, hoping to find someone to whom they could sell their shares. (Technically, you can do this. You don't have to sell your shares on a stock exchange. You can take physical possession of your stocks in certificate form, endorse them, and sign them over to someone in exchange for payment in your lawyer's office, or at your dining room table if you are so inclined. When the stock exchange was closed during World War I, many people did just that, creating a secondary shadow market.
The downside is that there is no transparency. Nobody knows what the best price is for a given stock at any given moment in time. You could be selling your shares for $50 while the guy two towns over is getting $70.) With a stock exchange, you will never know the person on the other end of the trade. He, she, or it could be halfway around the world. It could be a retired teacher. It could be a multi-billion dollar insurance group. It could be a publicly-traded mutual fund or hedge fund.
The need for convenience is what led to the establishment of the biggest stock exchange in the world. In the United States, a group of stockbrokers met under a buttonwood tree in New York City. On May 17th, 1792, twenty-four of these stockbrokers got together outside of 68 Wall Street to sign the now-famous Buttonwood Agreement, which effectively created the New York Stock & Exchange Board. Almost three-quarters of a century later, in 1863, it was officially renamed the New York Stock Exchange. These days, most people refer to it as the NYSE.
At one time, the United States had thriving regional stock exchanges that were major hubs for their particular part of the country. In San Francisco, for example, the Pacific Stock Exchange had an open outcry system where brokers would handle buy and sell orders for local investors who wanted to purchase or liquidate their ownership stakes. Most of these were shut down, purchased, absorbed, or merged following the rise of the microchip, which made electronic networks much more efficient for finding liquidity so that an investor in California could just as easily sell his or her shares to someone in Zurich.
According to Wikipedia's List of Stock-Exchanges, the 20 biggest stock exchanges in the world by market capitalization (USD bn) of listed securities are:
Let's start with this basic truth: At its core, trading on a stock exchange is about laying out money today with the expectation of getting more money back in the future — which, accounting for time, adjusting for risk, and factoring in inflation, results in a satisfactory compound annual growth rate, particularly as compared to standards considered a "good" investment.
That's really it; the heart of the matter. You lay out cash or assets now, in the hope of more cash or assets returning to you tomorrow, or next year, or next decade.
Most of the time, this is best achieved through the acquisition of productive assets.
Productive assets are investments that internally throw off surplus money from some sort of activity. For example, if you buy a painting, it isn't a productive asset. One hundred years from now, you'll still only own the painting, which may or may not be worth more or less money. (You might, however, be able to convert it into a quasi-productive asset by opening a museum and charging admission to see it.) On the other hand, if you buy an apartment building, you'll not only have the building but all of the cash it produces from rent and service income over that century. Even if the building were destroyed after a decade, you still have the cash flow from ten years of operation — which you could have used to support your lifestyle, given to charity, or reinvested into other opportunities.
Each type of productive asset has its own pros and cons, unique quirks, legal traditions, tax rules, and other relevant details. Broadly speaking, investments in productive assets can be divided into a handful of major categories. Let's walk through the three most common kinds of investments: Stocks, bonds, and real estate.
When people talk about investing in stocks, they usually mean investing in common stock, which is another way to describe business ownership or business equity. When you own equity in a business, you are entitled to a share of the profit or losses generated by that company's operating activity. On an aggregate basis, equities have historically been the most rewarding asset class for investors seeking to build wealth over time without using large amounts of leverage.
At the risk of oversimplifying, I like to think of business equity investments as coming in one of two flavors — privately held and publicly traded.
Investing in Privately Held Businesses: These are businesses that have no public market for their shares.
When started from scratch, they can be a high-risk, high-reward proposition for the entrepreneur. You come up with an idea, you establish a business, you run that business so your expenses are less than your revenues, and you grow it over time, making sure you are not only being well-compensated for your time but that your capital, too, is being fairly treated by enjoying a good return in excess of what you could earn from a passive investment. Though entrepreneurship is not easy, owning a good business can put food on your table, send your children to college, pay for your medical expenses, and allow you to retire in comfort.
Investing in Publicly Traded Businesses: Private businesses sometimes sell part of themselves to outside investors, in a process known as an Initial Public Offering, or IPO. When this happens, anyone can buy shares and become an owner.
The types of publicly traded stocks you own may differ based on a number of factors. For example, if you are the type of person that likes companies that are stable and gush cash flow for owners, you are probably going to be drawn to blue-chip stocks, and may even have an affinity for dividend investing, dividend growth investing, and value investing.
On the other hand, if you prefer a more aggressive portfolio allocation methodology, you might be drawn to investing in the stock of bad companies, because even a small increase in profitability could lead to a disproportionately large jump in the market price of the stock.
Exchange-Traded-Funds or ETFs give you a way to buy and sell a basket of assets without having to buy all the components individually. The ETF provider owns the underlying assets, designs a fund to track their performance and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they don’t own the underlying assets in the fund. Even so, investors in an ETF that tracks a stock index get lump dividend payments, or reinvestments, for the stocks that make up the index. (Related: Learn how to invest in index funds.)
While ETFs are designed to track the value of an underlying asset — be it a commodity like gold or a basket of stocks such as the S&P 500 — they trade at market-determined prices that usually differ from that asset. What’s more, because of things like expenses, longer-term returns for an ETF will vary from those of its underlying asset.
When you buy fixed-income security, you are really lending money to the bond issuer in exchange for interest income. There is a myriad of ways you can do it, from buying certificates of deposit and money markets to investing in corporate bonds, tax-free municipal bonds, and U.S. savings bonds.
As with stocks, many fixed-income securities are purchased through a brokerage account. Selecting your broker will require you to choose between either a discount or full-service model. When opening a new brokerage account, the minimum investment can vary, usually ranging from $500 to $1,000; often even lower for IRAs or education accounts. Alternatively, you can work with a registered investment advisor or asset management company that operates on a fiduciary basis.
Real estate investing is nearly as old as mankind itself. There are several ways to make money investing in real estate, but it typically comes down to either developing something and selling it for a profit, or owning something and letting others use it in exchange for rent or lease payments. For a lot of investors, real estate has been a path to wealth because it more easily lends itself to using leverage. This can be bad if the investment turns out to be a poor one, but, applied to the right investment, at the right price, and on the right terms, it can allow someone without a lot of net worth to rapidly accumulate resources, controlling a far larger asset base than he or she could otherwise afford.
Something that might be confusing for new investors is that real estate can also be traded like a stock. Usually, this happens through a corporation that qualifies as a real estate investment trust or REIT. For example, you can invest in hotel REITs and collect your share of the revenue from guests checking into the hotels and resorts that make up the company's portfolio. There are many different kinds of REITs; apartment complex REITs, office building REITs, storage unit REITs, REITs that specialize in senior housing, and even parking garage REITs.
Stock exchanges have a range of pros and cons for both the companies that are listed on them and for the individuals seeking to trade on them.
Pros of stock exchanges
Cons of stock exchanges
Traders and investors can manage their exposure to stock market volatility by implementing a risk management strategy.
Once you've settled on the asset class you want to own, your next step is to decide how you are going to own it. To better understand this point, open an investing account with virtual money (stock market simulator) and build a portfolio composed of stocks, indexes, and ETFs.
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