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Stock Exchange
By SOFIA of Moneyvally.com
Most stocks are traded on exchanges, which are places where buyers and sellers meet
and decide on a price. Some exchanges are physical locations where transactions are carried out
on a trading floor. You've probably seen pictures of a trading floor, in which traders are
wildly throwing their arms up, waving, yelling, and signaling to each other.
The other type of exchange is a virtual kind, composed of a network of computers where trades
are made electronically. The purpose of a stock market is to facilitate the exchange of
securities between buyers and sellers, thus reducing the risks of investing. Just imagine how
difficult it would be to sell shares if you had to call around the neighborhood trying to find a
buyer. Really, a stock market is nothing more than a super-sophisticated farmers market linking
buyers and sellers.
Before we go on, we should distinguish between the "primary" market and the "secondary" market.
The primary market is where securities are created (by means of an IPO) while, in the secondary
market, investors trade previously-issued securities without the involvement of the issuing-
companies. The secondary market is what people are referring to when they talk about "the stock market."
It is important to understand that the trading of a company's stock does not directly involve
that company. To learn more about this, see our article entitled "Where Securities Are Traded."
The New York Stock Exchange The most prestigious exchange in the world is the New York Stock
Exchange (NYSE). The "Big Board" was founded over 200 years ago in 1792 with the signing of the Buttonwood
Agreement by 24 New York City stockbrokers and merchants. Currently the NYSE, with stocks like
General Electric, McDonald's, Citigroup, Coca-Cola, Gillette, and Wal-mart, is the market of
choice for the largest companies in America.
The NYSE is the first type of exchange (as we referred to above), where much of the trading is
done face-to-face on a trading floor. This is also referred to as a "listed" exchange. Orders
come in through 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 buyers and sellers. Prices are determined using an auction
method: the current price is the highest amount any buyer is willing to pay and the lowest
price at which someone is willing to sell.
Once a trade has been made, the details are sent
back to the brokerage firm, who then notifies the investor who placed the order. Although
there is human contact in this process, don't think that the NYSE is still in the Stone Age;
computers do play a huge role in the process.
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Typically, we will pay a small premium for each option we buy. For instance we will pay one price for the call option and we will pay another price for our put option. The great thing about investing in this option trading strategy is we are only risking our premiums. However, if the stock does have the volatility we anticipate, we can close out one of our option positions as the stock moves favorably towards the other option position. This will limit our loss, but give us unlimited gains.
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