This post is Part 2 of a Beginner’s Guide to Stock Investing series.
Part Two: What Is the Stock Market?
In December of 1980, a computer company founded out of a garage in Los Angeles, California, began trading on a stock exchange known as the National Association of Securities Dealers Automated Quotations (NASDAQ). At the end of its first day of trading, the company had a total market value of approximately $1.8 billion.
Fast forward forty-five years and that company, Apple, Inc., has a total market value of over $4 trillion. A $10,000 investment made when Apple first became a publicly traded company would be worth over $22 million by 2026.
When most people think of the “stock market,” they think of publicly traded stocks such as Apple, Microsoft, or Wal-Mart. But publicly traded stocks are just one component of the broader market for stock shares.
In Part 1 of this series, I explained what a stock represents — an ownership interest in a business — which provides important context for understanding how those shares trade in public markets.
So, what is the stock market, and how does it function?
The Two Parts of the Stock Market
We can think of the stock market as consisting of two markets:
- The primary stock market
- The secondary stock market
In the primary market, a company raises capital by selling shares directly to investors. The company itself is a party in the transaction and receives the funds from the sale.
In the secondary market, stocks are bought and sold among investors and traders; the company is not involved in the transaction.
In this post, we’ll focus on secondary markets.
From Private Company to Public Listing: The IPO Process
Let’s go back and look at Apple, Inc. The company was not always publicly traded. Before Apple “went public” in 1980, the company raised money by selling shares to its founders (Steve Jobs and Steve Wozniak), venture capital firms, and other investors. But in 1980, the company did an initial public offering (IPO), which allowed it to access a larger pool of capital in the public markets.
IPOs are how companies move from the primary market to the secondary market. The IPO process is managed by a financial institution known as an investment bank. When a company wants to list its shares in the secondary market, it works with an investment bank which creates an underwriting syndicate with other investment banks. The syndicate purchases the shares the company is issuing and then resells those shares to investment institutions. This is known as a “bought deal” and is the most common IPO process.
Why Do Companies Go Public?
Why do companies list their shares on an exchange? If I were writing this post twenty-five years ago, I would say one of the reasons was to provide Why do companies list their shares on an exchange?
If I were writing this post twenty-five years ago, I would say one of the reasons was to provide companies with access to capital. But over the last several decades, private markets have grown so large that companies can easily raise tens of billions of dollars in capital without accessing public markets.
Today, the appeal of a public listing is mainly to provide:
- Liquidity to the company’s founders and early investors
This is not easily done while a company is still private. By liquidity, we mean the ability to convert shares into cash. - Price discovery
By price discovery, we mean that a public company can rely on the market – i.e., the aggregation of analysts, portfolio managers, and traders – to place an informed price on the company’s shares.
These two factors – liquidity and price discovery – allow founders and early investors to “cash out” at least a portion of their shares, often at a much higher price than they would receive in a private transaction.
How Public Markets Function
Once a company is listed on an exchange, its shares are available for trading by anyone with a brokerage account.
Central to public stock markets are firms called broker-dealers. The terms broker and dealer refer to the capacities in which a firm operates. Brokers act as agents, merely matching transactions between buyers and sellers. Dealers buy and sell securities for their own account. The same firm may operate in both capacities. Investors must have an account with a registered broker to be able to buy and sell stocks.
The Major U.S. Exchanges
There are two major exchanges in the US. They are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ).
The NYSE began on May 17, 1792, when twenty-four stockbrokers met under a buttonwood tree on New York’s Wall Street. They were there to sign an agreement outlining rules for how stocks were to be traded and the commissions which were to be paid on each transaction. The NYSE maintains a physical location where some larger institutional orders are traded, but most transactions occur electronically.
The NASDAQ, in contrast, is a fully electronic exchange. When the NASDAQ launched in 1971, it was a network for brokers and dealers to post quotes on securities not listed on an exchange. As that network grew, the NASDAQ became an established stock market where companies would list exclusively. Today, the NASDAQ is the home to some of the largest and most innovative companies, such as META, Alphabet, Apple, and NVIDIA.
Both the NYSE and the NASDAQ use designated market makers (DMMs) to facilitate the trading of stocks. The DMMs are members of the stock exchange. Their role is to maintain fair and orderly trading in a particular stock. The DMMs must purchase stock if no buy order can be found and they must sell stock from their own inventory if no sell orders can be found.
Another component of the secondary market is the over-the-counter (OTC) market. OTC markets do not use market makers. Rather, stocks are traded directly among brokers. These stocks are (generally) significantly riskier than shares listed on an exchange. This is because OTC stocks are less regulated and because OTC stocks are significantly less liquid, due to less buyers and sellers in these shares.
Regulation of Public Markets
Public markets are regulated by the Securities and Exchange Commission (SEC) and by self-regulatory organizations (SROs).
The SEC is a government agency formed in 1934 with the passage of the Securities and Exchange Act. The SEC is tasked with enforcing federal securities laws. They are the highest federal authority regulating securities brokers, dealers, issuers, and money managers. They are also tasked with promoting fair and transparent markets. All broker-dealers must register with the SEC.
There are various SROs that also regulate markets. The exchanges themselves are SROs and enforce rules among their members. The main SRO is the Financial Industry Regulatory Authority (FINRA). FINRA operates under the oversight of the SEC. FINRA is the organization responsible for licensing of securities brokers and investment professionals.
If you have not yet read Part 1 of this series, where I explain what a stock is and what ownership truly represents, you can read Part 1: What Is a Stock here.
Summary
The stock market consists of two interconnected parts: the primary market, where companies raise capital by issuing shares, and the secondary market, where investors buy and sell shares among themselves. While the primary market allows companies to access capital, the secondary market provides liquidity and continuous price discovery.
Companies enter public markets through an initial public offering (IPO), typically managed by investment banks. Once listed, shares trade on exchanges such as the NYSE and NASDAQ, facilitated by broker-dealers and market makers who help maintain orderly markets.
Public markets operate under regulatory oversight from the SEC and self-regulatory organizations like FINRA. Understanding how these pieces fit together provides essential context for investors who want to view stocks not just as ticker symbols, but as ownership interests trading within an organized marketplace.
Key Takeaways
- The stock market consists of both primary and secondary markets.
- The primary market allows companies to raise capital directly from investors.
- The secondary market enables investors to buy and sell shares among themselves.
- IPOs move companies from private ownership into public trading.
- The main benefits of going public are liquidity and price discovery.
- The NYSE and NASDAQ are the two major U.S. stock exchanges.
- The SEC and FINRA regulate public markets to promote fairness and transparency.
