Now that you have set up your stock trading account, I’m sure you’re raring to get out there and make some money!
Well sorry to burst your bubble, but merely setting up a brokerage account is only the first step on your stock trading journey. The next course of action would be to examine and consider the various types of stock markets available to you. Much like choosing your ideal brokerage firms, different exchanges present a variety of pros and cons for individual investors. As such, traders would do well to do some research on which markets are most suitable for themselves before going any further. Fortunately for you, we have compiled a short summary of all the different types of stock markets in the sections below. But first, it would be prudent to clarify…
What exactly is a stock market?
A stock market is defined as an exchange which provides a medium for the transfer of public company equity between individuals and institutions. In other words, it allows people to buy and sell shares of companies that are currently listed on that particular stock market.
The process in which companies actually go about listing on a stock exchange is known as an Initial Public Offering (IPO). Going public allows companies to access capital from public investors in exchange for a portion of ownership. This initial issuance of a company’s shares are done through Primary Markets, which are platforms where companies directly sell their shares to interested investors. The IPO process is an arduous process which involves the company working alongside investment bankers towards the sale of large quantities of their stock within a tight time frame. Due to the size and duration of the investment, the stock is typically marketed towards large institutional investors which can afford it. So unless you manage a hedge fund or work at Goldman Sachs, you can forget about getting involved in Primary Markets.
What is more pertinent to our interests is the Secondary Markets. These are exchanges where shares are traded between investors independent of the company in question. This includes the Singapore Exchange (SGX), New York Stock Exchange (NYSE) and other such well known bourses. It is therefore the various differences, be they minor or significant, between the Secondary Markets that retail investors such as ourselves should be concerned with. That being said, the following market types are all classified as Secondary Markets.
Auction Markets are exchanges where buyers and sellers openly announce the price point at which they are willing to sell or buy a stock. The actual transaction process is regulated by ‘specialists‘ designated by the exchange itself in order to provide an efficient marketplace for each specific stock. These auctioneers match bids together to complete a trade, thereby setting the current share price at the most recent transaction price. While the majority of trades today might be done electronically, these markets traditionally made use of an open outcry system where buyers and sellers would physically call out prices. This results in the sort of controlled chaos commonly depicted in the media, which has deeply ingrained the mental images of flying papers and frantic shouting men into our collective consciousness. Perhaps the most famous example of this is the NYSE, which is not only the largest auction market but is also the world’s largest stock market in terms of the market capitalisation of its listed companies.
On the other hand, dealer markets employ various market makers to create a market for stocks. Otherwise known as ‘dealers‘, these individuals hold large quantities of the stock and are meant to set both ask and bid prices. Thus traders are no longer dealing with each other and instead transact directly with the dealers, who in turn respond to supply and demand trends in the financial markets. The most prominent example of a dealer market is the Nasdaq, which currently lists many of the world’s tech giants such as Amazon and Google. Much like the companies listed there, trading on the Nasdaq is a technologically advanced affair. Consequently every trade is performed on their computerised trading platform which acts as a sophisticated alternative to the ‘specialist’ system practiced by the NYSE.
Electronic Communication Networks (ECNs)
An even more technologically dependent trading solution is the use of ECNs. These are platforms by which buyers and sellers can connect to each other directly, thereby foregoing the need for any third-party market makers. While still an emerging concept, they pose a serious threat to the continued existence of traditional stock markets as they cut down on the transaction costs typically imposed upon traders. Nevertheless, they currently focus on institutional investors and retail investors like us are left hanging. A few pertinent examples of the original ECNs include INET as well as Archipelago which were recently acquired by Nasdaq and the NYSE respectively. Within Asia, ToSTNeT (Tokyo Stock Exchange Trading NeTwork) system offer investors ways of executing various transactions such as block trading and basket trading during off-auction hours.
Over-the-Counter (OTC) Markets
These generally refer to any other exchanges that aren’t classified into the above categories. As exchanges held in lower esteem than their more popular counterparts, these markets usually list smaller companies. This is aided by the fact that listing on these exchanges places a comparatively lower administrative burden and cost on companies. The other kind of companies you can find on these exchanges are those which have been delisted from more established markets due to a failure to comply with their strict regulation laws. Some OTC markets in the US include Over-The-Counter-Bulletin-Board (OTCBB) and OTC Pink, and in Asia, examples are SGX OTC and OTC Clear.
With that, we have run the gamut of all the different types of markets for discerning traders such as yourself to participate in. Still not in depth enough? Not to worry, as we will be examining the ins and outs of a few specific and relevant markets in our next article.