Wall Street has been the epicenter for the American and world economy for almost 100 years. Before that, it was London, and before that, Rome. Part of what has made thses places so important to the world economy is that they were centers of trade and then centers of finance. This is because businesses need money to finance their trade. The traditional methods of raising money for business are to borrow it or get investors. You may loan money to a business or invest in it, but you may not want ti wait for them to pay you back per the terms of your agreement. You could sell your rights to the debt repayment or profits to an investor willing to take that risk. The stock market was born as a formalized process to allow the investors to sell their rights to profits to someone else.
The stock market is the entire business of buying and selling stocks. A stock exchange is a specific place where the buying and selling occurs. It’s a small distinction, but an important one. The purpose of this “course” is to talk about the exchanges themselves. For purposes of illustration, I’ll mostly focus on the New-York Stock Exchange.
The New-York Stock Exchange (NYSE) was born out of an agreement among a couple dozen stock brokers in the late 1700s. They later formalized the agreement with a constitution and began the process of trading public company shares in an open environment. Over the years as companies learned they could raise capital from public offerings, more and more went to exchanges like the NYSE to raise money. But sometimes the NYSE wouldn’t accept them because there weren’t enough shares or the company was too small. Some independent brokers started meeting on the streets outside of the NYSE to trade these shares. The American Stock Exchange was born from this in the early 20th century. It was merged with the NYSE in 2008.
Trading in these exchanges was fairly simple. A broker had either a buy or sell order for a certain number of shares. They needed to find someone on the opposite side of the trade. This means they needed someone to buy what they’re selling or vice versa. The more brokers you had in one place, the easier this was. This is how exchanges start. The process has been formalized somewhat now though. On the floor of the NYSE there are people called “specialists”. They are market makers. So floor trader will go to the specialist for a certain stock and say they want to sell X shares at Y price. The market makers will try to match that order with another trader’s order to buy. If there isn’t sufficient demand for buying or selling, the specialist will make the trade themselves. This provides a measure of liquidity to markets that may otherwise freeze up. Who are the market makers? There are thousands of them. But they are companies with large amounts of money to invest. Though I don’t know for sure, the specialists acutally on the floor of the NYSE probably represent the major investment companies on Wall Street. Since all the major players are market makers, no one firm has a specific advantage over another.
These days the floor of the NYSE isn’t as busy as it once was. That’s because the exchange has opened up trading to electronic markets, the same way the NASDAQ does. 85% of the trades on the NYSE are done electronically now. The rest are still done on the floor of the exchange. The advantage on the floor is you have human interaction. They can make split second decisions to help avoid situations such as the flash crash. But despite a technical setback or two, electronic trading is faster, and more efficient. The days of the specialist on the floor are numbered.
In a few more years, there won’t even be a real floor to any exchange. Stock exchanges will all be electronic. You’ll still need to market makers, but this can be done online. The NYSE remains one of the best places to be listed for a public company, as more money flows through there than any place else. If you ever have the opportunity to visit an exchange I’d suggest you take up on the offer. If there is single location that can be designated as the center of the economy, it’s in an exchange.
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
