What a stock exchange is
A stock exchange is a regulated marketplace where buy and sell orders meet. When you buy a share there, you almost always buy it from another investor who wants to sell right now, and not from the company.
Learning objective: After this lesson you can explain who is really on the other side when you buy on the stock exchange.
Many people think companies sell their shares on the stock exchange. That's only true the very first time, at the IPO. After that, investors trade with each other.
Where your money goes
When Emma buys an Adidas share, Adidas doesn't get a cent of it. Her money goes to the person who owned the share before. The exchange just makes sure the two find each other and that everything follows the rules.
How the price forms
The price comes from two numbers: the most buyers are willing to pay and the least sellers are willing to accept. When they match, a trade happens. The price of the last trade is the price you see in your app.
The price is not a grade
So the price isn't a grade for the company. It shows what two sides last agreed on, often two computer programs. In the long run it follows how the company is doing. In the short run it sometimes has little to do with it.
There are two markets. On the primary market the company receives money, for example at the IPO or in a capital increase. On the secondary market existing shares only change owners. It still matters to companies. Only because you can sell a share again at any time are you willing to buy in at the IPO at all. That liquidity is the real purpose of ongoing trading.
The order book
In ongoing trading the exchange collects all orders in an order book, sorted by price and time. The highest buying price is the bid, the lowest selling price the ask, and the gap between them the spread. When a new order meets a matching old one, a trade happens. So the price is always the price of a single past trade. If you want 10,000 shares, you won't necessarily get them at that price.
Off-exchange venues
Besides exchanges there are off exchange venues, where a partner of your broker takes the other side of your trade directly. If that partner pays the broker for it, there's a conflict of interest. So don't just compare order fees. Also check how wide the spread is and at what price your orders are really filled.
Summary
- When you buy a share, you pay another investor, not the company.
- The price is the price of the last trade and not a valuation.
- The spread costs you money, even though it isn't listed as a fee anywhere.
Did you get it?
Does a company get money when you buy its shares?
Only at the IPO or in a capital increase. In normal trading your money goes to the previous owner.
What exactly does the displayed price tell you?
The price of the last trade. It doesn't mean any number of shares is available at that price.
Why isn't it enough to compare order fees?
Because the spread and the execution price cost extra without being shown as a fee.
Check your understanding
Your task
Buyers will pay at most $31.40 for a stock, and sellers ask at least $31.60. Does a trade happen? What must change for one to happen, and who receives the money in a purchase at $31.60?
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- Why prices moveStage 1
- Investing and trading are two different thingsStage 1
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