Stock Basics: How to trade stock

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. 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. 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.

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 Nasdaq

The second type of exchange is the virtual sort called an over-the-counter (OTC) market, of which the Nasdaq is the most popular. These markets have no central location or floor brokers whatsoever. Trading is done through a computer and telecommunications network of dealers. It used to be that the largest companies were listed only on the NYSE while all other "second tier" stocks traded on the other exchanges. The tech boom of the late 90s changed all this; now the Nasdaq is home to several big technology companies such as Microsoft, Cisco, Intel, Dell, and Oracle. This has resulted in the Nasdaq becoming a serious competitor to the NYSE.

On the Nasdaq brokerages act as "market makers" for various stocks. A market maker provides continuous bid and ask prices within a prescribed percentage spread for shares for which they are designated to make a market. They may match up buyers and sellers directly but usually they will maintain an inventory of shares to meet demands of investors. We won't get into the process here since we cover this in detail in our tutorial entitled "Electronic Trading and Market Makers."

Other Stock Exchanges

The third largest exchange in the U.S. is the American Stock Exchange (AMEX). The AMEX used to be an alternative to the NYSE, but that role has since been filled by the Nasdaq. In fact, the National Association of Securities Dealers (NASD), which is the parent of Nasdaq, bought the AMEX in 1998. Almost all trading now on the AMEX is in small-cap stocks and derivatives.

There are many stock exchanges located in just about every country around the world. American markets are undoubtedly the largest and thus most important, but they still represent only a fraction of total investment around the globe. The two other main financial hubs are London, home of the London Stock Exchange, and Hong Kong, home of the Hong Kong Stock Exchange. We've got a complete list of exchanges from around the world here.

The last place worth mentioning is the over-the-counter bulletin board (OTCBB). The Nasdaq technically is an over-the-counter market, but the term commonly refers to small public companies that don't meet the listing requirements of any of the regulated markets, including the Nasdaq. The OTCBB is home to penny stocks because there is little to no regulation. This makes investing in an OTCBB stock very risky. You really need to know what you're doing here or you'll get burnt!