A stock exchange is a centralized marketplace where shares of publicly traded companies are bought and sold. Exchanges differ from other stock exchanges in that tradable assets are limited to shares, bonds and ETPs (exchange traded products).
The main difference between exchange and over-the-counter (OTC) trading is that, at the exchange level, transactions are arbitrated and are not directly between two parties. This means that there is stricter regulation for investors and speculators, as well as for listed companies.
Companies often have to meet specific standards before they can be listed on a stock exchange - these standards may vary from stock exchange to stock exchange. For example, the Nasdaq requires companies to have a market value of $70 million before they can be listed, while the New York Stock Exchange (NYSE) requires a company to have a value of $100 million.
Advantages and disadvantages of stock exchanges
Stock exchanges offer a multitude of advantages and disadvantages, both for the companies listed on them and for the people who invest in them.
Advantages of stock exchanges
For a company, being listed on the stock exchange represents a certain prestige. This is particularly the case for the oldest stock exchanges, such as those in Amsterdam, London and New York. Being listed on the stock exchange also means that investors can buy shares in the company, which helps a company's expansion by raising funds.
Trading on the stock exchange is much fairer for investors who are less exposed to the risk of default by a counterparty. This is because of the high levels of regulation in the stock markets, which is not the case with over-the-counter (OTC) trading.
Finally, online brokerage firms have made it easier for traders to access stock markets and have enabled them to take advantage of short-term market movements.
Disadvantages of exchanges
Listing a company on the stock exchange can be long and expensive. And once it is listed, it will have to consider its responsibilities to shareholders, who will hold shares in the company.
Trading on a stock exchange does not guarantee stability. Stock markets are sensitive to market volatility, which means that there can be dramatic fluctuations in share prices, usually in response to political and economic events around the world.
Stock markets can also experience crashes. Although they are rare, stock market crashes can significantly reduce the value of shares and cause economic depressions that last for years.
Traders and investors can manage their exposure to stock market volatility by establishing a risk management strategy.