How Stock Markets Work
The Mechanics of Trading and Market Operations
Learn about exchanges, market makers, bid-ask spreads, and the mechanics of buying and selling stocks. Understanding these fundamentals is essential for any successful investor.
Stock Exchanges
Stock exchanges are organized marketplaces where securities are bought and sold. They provide the infrastructure for trading and ensure fair, orderly markets.
New York Stock Exchange (NYSE)
- • Largest stock exchange by market cap
- • Hybrid auction/electronic system
- • Home to blue-chip companies
- • Designated Market Makers (DMMs)
NASDAQ
- • Fully electronic exchange
- • Tech-heavy listings
- • Multiple market makers compete
- • Fast execution speeds
Regional & International
- • Regional exchanges (CBOE, IEX)
- • International markets (LSE, TSE)
- • Alternative Trading Systems (ATS)
- • Dark pools for large trades
Trading Hours
Regular Hours: 9:30 AM - 4:00 PM ET
Pre-Market: 4:00 AM - 9:30 AM ET
After-Hours: 4:00 PM - 8:00 PM ET
Market Makers & Liquidity
Market makers are firms that provide liquidity by continuously buying and selling securities. They profit from the spread between bid and ask prices while ensuring there's always someone to trade with.
How Market Makers Work
- • Continuously quote bid and ask prices
- • Must buy when others want to sell
- • Must sell when others want to buy
- • Manage inventory risk throughout the day
- • Profit from the bid-ask spread
Benefits to Investors
- • Improved liquidity and faster execution
- • Tighter bid-ask spreads
- • Ability to trade large quantities
- • Market stability during volatility
Major Market Makers
- • Citadel Securities
- • Virtu Financial
- • Jane Street
- • Two Sigma
- • Optiver
Regulatory Oversight
- • SEC rules and monitoring
- • Best execution requirements
- • Market maker obligations
- • Fair and orderly markets
Understanding Bid-Ask Spreads
BID
$99.95
Highest price buyers are willing to pay
SPREAD
$0.10
Difference between bid and ask
ASK
$100.05
Lowest price sellers are willing to accept
Factors Affecting Spreads
Liquidity
More liquid stocks have tighter spreads due to higher trading volume.
Volatility
Higher volatility leads to wider spreads as market makers increase risk premiums.
Market Conditions
Spreads widen during market stress and narrow in calm conditions.
Trading Impact
Market Orders
Execute immediately at current market prices (bid for sells, ask for buys).
Limit Orders
Only execute at specified price or better, potentially avoiding spread costs.
Cost Consideration
Wide spreads increase trading costs, especially for frequent traders.
Types of Orders
Market Order
Buy or sell immediately at the current market price.
Pros: Guaranteed execution, immediate fill
Cons: No price control, potential slippage
Best for: Liquid stocks, urgent trades
Limit Order
Buy or sell only at a specified price or better.
Pros: Price control, no worse execution
Cons: May not execute, partial fills possible
Best for: Price-sensitive trades, patient investors
Stop Order
Becomes a market order when price reaches stop level.
Pros: Limits losses, automated execution
Cons: No guaranteed price, gap risk
Best for: Risk management, exit strategies
Stop-Limit Order
Combines stop and limit orders for price protection.
Pros: Price control with stop protection
Cons: Complex, may not execute
Best for: Sophisticated risk management
Time-Based Orders
Day Order:
Expires at end of trading day
Good-Till-Canceled (GTC):
Remains active until filled or canceled
Fill-or-Kill (FOK):
Must be filled completely or canceled
⚠️ Order Tips
- • Use limit orders for better price control
- • Be careful with stop orders in volatile markets
- • Consider order size relative to daily volume
- • Monitor orders during market hours