This is the second article in our guide to stocks. In this article, we’ll tell you how stocks are traded and who’s trading them. For our first article, which discussed what stocks actually are, click here.

History

The date – May 17, 1792.  The place – New York City, 68 Wall Street, outside under a buttonwood tree.  The event – 24 stock brokers have just signed an agreement to create the ancestor of what is today’s largest stock exchange by total company value.

That’s right, you guessed it, it’s the birth of the New York Stock Exchange (NYSE), and if you’re curious as to what it actually means to buy and sell stocks, how they’re sold, and who’s selling them, you’re in the right place.  In the last article, we showed you what a stock actually is – a share of ownership in a company.  It’s important to keep in mind that, officially, each share of stock is represented by an actual piece of paper that outlines the details (company name, proof of ownership, etc) of the stock that you own.  These days, these records may be held electronically, but back in the ol’ days, they were actual products that were bought and sold for money.

Anyone that wanted to buy or sell stock would instruct their broker to go down to the physical location of the stock exchange and come up with a favorable deal.  These brokers would then exchange stock certificates for cash and either provide them to their clients or hold them until their clients needed them.

Trading today

Today, things are a bit different.  The NYSE has expanded, and though there’s still some human interaction left in the trading process, most deals are done electronically on a vast computer system.  In addition, the NYSE isn’t the only player in town anymore.  The NASDAQ is a fully electronic exchange that matches buyers and sellers and provides a centralized location for trading stocks (not to mention other financial products).  It’s the second largest exchange in the US, and it’s known for housing mostly tech stocks.  These are the two big exchanges that you should know about, though it may also help to keep in mind the American Stock Exchange, which is the third largest exchange, though these days it doesn’t focus too much on stocks.

There are a lot more brokers now, too.  And you’ll probably never see a stock certificate in your life, but the basic idea is the same.  Exchanges provide a way for buyers and sellers to trade stocks quickly and easily.

So who’s doing all the trading?

The total market value of all of the companies in the NYSE alone is around $18 trillion (after they merged with the electronic exchange Euronext).  On top of that, there are around 2 billion shares traded every day, amounting to hundreds of billions of dollars of transactions.

Who’s doing all this trading?

Well, obviously there are a lot of individual traders, but the majority of trading is done by banks and institutional investors – or the big companies that are hired to manage your pension funds, 401(k)s, the endowment funds of big schools like Harvard and Yale, sovereign wealth funds that manage the money of entire countries, hedge funds, mutual funds, and any other large organizations that are entrusted with the savings of millions of working professionals for safekeeping.

These companies are all employing their own investment strategies, analyses, calculations, opinions, and most importantly, emotions, to try to find stocks that will help them grow their capital.  If any single of of them puts in a large order to buy or sell stock, it will flood the market and can significantly move prices up or down.  In the next post, we’ll talk about what makes up the price of a stock, but for now, it’s enough to know that these guys play a big roll in the whole process of supply and demand.

Market making

There’s one last thing you should know about stock trading, at least for now.  When most individuals place an order to buy or sell a stock, they’re actually going through an intermediary – or a market maker.  These are people (or companies) that are required to “provide a market” for stocks buy buying and selling at the prices that they quote the public.  In exchange, they get preferential treatment in the markets whenever they place their own orders.

Market makers will always sell stock at a slightly higher price than they buy it, which brings them a small profit on every transaction they do.  Good traders or computer programs that do this thousands, or millions, of times a day can generate huge amounts of money, so market making is a pretty lucrative business.

When you put in an order to buy or sell a stock, chances are it’s going from you to your broker to a market maker who may or may not match you up with another buyer or seller in the market.  If there’s no match, the market maker will just take your order and wait until later in the day when he can offset his new position, and in a market that’s trading billions of shares a day, that’s usually not too hard to do.

What’s next?

At this point, you know what stocks are, why companies sell them, why people trade them, and how they’re bought and sold.  But the most important part is yet to come.  In the next article, we’ll tell you what stock prices mean and why they can move so far up and down in such short timespans.  Read on!