What is an exchange and how does it work?

exchange and how does it work

Access to financial markets is provided through a platform called an exchange. Today we will figure out what it is, how trading is carried out on the exchange, and how to become a participant in trading.

Concept and classification of exchanges

An exchange is a platform on which trades in financial instruments are organized and conducted. Depending on the type of traded assets, exchanges can be divided into the following types:

  • Stock exchange – a platform on which securities trading is organized. Here, transactions are carried out with stocks, bonds, investment funds’ units, ETFs and other instruments that belong to the category of securities. Currently, the largest stock exchange in the world is NYSE – New York Stock Exchange.
  • Foreign exchange – here you can trade foreign currencies. Buying and selling currency can be done in the bank, but it is more profitable to do it through the exchange. The most famous exchanges for currency transactions are the London International Financial Futures Exchange and the European Options Exchange in Amsterdam.
  • Commodity exchange – a platform for trading raw materials, energy resources, precious metals. Basically, trading on commodity exchanges is carried out between legal entities that sell large volumes of products. Private investors practically do not carry out transactions on such sites. The largest commodity exchange is the Chicago Mercantile Exchange CME.
  • Cryptocurrency exchange – here, as its name mentions, transactions are made exclusively with cryptocurrency. Despite the fact that digital currency trading has gained popularity relatively recently, today there are already a sufficient number of cryptocurrency exchanges. The most famous are Binance and KuCoin.

In addition to the listed types of exchanges, there are so-called universal platforms where you can perform transactions with different classes of assets. For example, this type includes the Moscow Exchange, which provides access to trading in shares of Russian issuers, currencies, certain types of commodities and derivatives.

Exchange participants

The main participants in trading on the exchange are issuers, investors and professional market participants.

  • Issuers are legal entities that issue securities in order to attract financing. These can be individual companies, cities, or even a state.
  • Investors are bidders who wish to acquire certain assets. An investor can be either an individual or a legal entity.
  • Professional market participants are intermediaries between investors and issuers who have passed the licensing procedure. In particular, we are talking about brokers, dealers, depositories and trustees. In addition to intermediary function, they carry out the functions of registration, storage and accounting of monetary funds and assets circulating on the exchange, as well as the functions of tax agents and asset managers on behalf of the investor.

Also, the exchange is controlled by financial regulators, which, among other things, carry out licensing of professional market participants. In the US, this function is performed by the Securities and Exchange Commission (SEC), in Russia by the Central Bank, and in the UK by the Financial Conduct Authority (FCA).

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Exchange functions

The main functions of the exchange include:

  • Organization of exchange trading. A modern exchange is a centralized digital environment that allows a large volume of transactions with assets by all trading participants. Its main task is to ensure a smooth e-commerce process.
  • Development of trading rules and standards for traded instruments. All instruments traded on a particular website are rigorously selected for compliance with established standards.
  • Dispute resolution. In the course of exchange trading, disputes may arise between their participants. The responsibility for resolving controversial issues lies with the exchange.
  • Determination and regulation of exchange prices. All assets are initially traded at a price set by the seller. However, depending on supply and demand, the price may change. The exchange’s job is to maintain a fair market price.
  • Redistribution of funds between industries, sectors of the economy, countries.
  • Guaranteed execution of transactions. Unlike the usual market, where you can be deceived and foisted with fake goods or cheated, such excesses will not happen on the stock exchange. It provides guaranteed execution of transactions under specified conditions.

Methods of working on the exchange

The work of private investors on the stock exchange involves two options: trading and investing. The first method involves active trading with the aim of making a profit due to fluctuations in quotes. The main task of a trader is to buy assets at the lowest price, and sell at the highest. Therefore, this style of trading is often called speculative. As for investments, they involve the acquisition of assets for a long time. The investor’s income consists of dividends and the difference in asset prices during their long-term growth. Therefore, investors, unlike traders, do not make a large number of transactions, but limit themselves to buying assets when forming an investment portfolio, as well as operations during its periodic rebalancing.

How to start trading on the exchange

A private investor does not have direct access to financial instruments. To do this, he or she needs an intermediary – a brokerage company. Also, access to trading in financial instruments can be provided by investment services, such as financial marketplaces – the services which combine a large number of offers from liquidity providers on one platform. Examples of such services are Bristol House Corporation (BHC) or BlackBull Markets. The advantage of the financial marketplaces is an access to a larger number of instruments. Brokerage companies, unlike them, usually have a limited range of assets.

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Regardless of whether you have chosen a broker or a financial marketplace as your intermediary, in order to access trading operations, you need to open and fund your deposit. The trading process itself is carried out using specialized trading terminals, in which the investor places orders to buy or sell assets. It is also possible to do this by phone, instructing the broker to conclude a deal on your behalf. However, this option is practically not used today. It is much more convenient to place an order from the phone using a mobile application, which the majority of trading terminals have.

When placing an order for the purchase of assets, you must indicate their quantity and the price at which you are ready to buy them. If the value of the price of your order coincides with the price set by the seller, the order is considered executed. Placing an order with an independently specified price value is called a limit order. The disadvantage of such orders is that if the set price does not coincide with the market price, such an order is canceled at the end of the trading day, and the next day it will have to be placed again. It is also possible to purchase assets at market prices. That is, you do not set a specific price value, but agree to the one that is valid at the moment. This type of orders is used for short-term transactions. After the trade is executed, your funds posted through the clearing center are credited to the seller’s account. And the assets you have acquired are registered with the depository, after which you can become their full-fledged owner.

Conclusion

Thus, the exchange is the central link in trading. Without it, asset trading would be impossible. When concluding deals, many private investors do not think about how the trading process takes place. All that is required of a trader is to open and replenish an account, select assets and leave a request to buy or sell them. The rest happens without his or her participation. In fact, making such transactions is a rather complicated process that requires organization. It is the function that the exchange undertakes.

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