How the stock exchange works

More than 150 million Americans have already opened trading accounts for the stock market, but as statistics show, two-thirds of them remain inactive. People are attracted by the opportunity to earn money in the securities market, but not everyone understands how to do it. We will explain how trading on the stock exchange works.

What is a stock exchange?

A stock exchange is an online platform where you can trade securities such as stocks, bonds, investment funds, and more complex instruments like options and futures.

The exchange ensures that all parties fulfill their obligations and that transactions are executed quickly and reliably. Only securities from verified companies are allowed for trading on the exchange, so you won’t encounter obvious fraudsters there. Since there are many sellers and buyers on the exchange, transactions are conducted at fair market prices.

To access the stock exchange, you will need a professional intermediary, such as a broker or a trustee. Brokers execute trades on your behalf, while you independently decide which securities to buy, sell, and when to do so. A trustee, on the other hand, makes these decisions for you based on a pre-agreed strategy.

Some types of securities can be bought and sold outside the stock exchange, and this method of trading is called over-the-counter (OTC) trading. Brokers and trustees are often the organizers of such transactions. However, OTC trading is associated with increased risks, as the prices of securities are often far from the market value. Additionally, the exchange does not vet the companies that issue them, making it difficult even for experienced investors to assess the likelihood of profit or loss.

It is even more dangerous to operate without the assistance of licensed intermediaries, as there is a high risk of encountering blatant scammers and losing money.

“My brother once received a call from an unknown number offering to engage in stock market trading. These individuals, who presented themselves as ‘brokers,’ promised training in an academy with the only requirement being to open an account. The conditions were that the money would be kept in a bank in Latvia, and it could be withdrawn at any time. My brother is a vigilant person, but they managed to persuade him…”

Where do securities come from?

Issuers, whether they are companies, governments, or regional entities, issue financial instruments to attract financing. Often, issuers simply want to borrow money from investors at an interest rate, and to do so, they issue bonds, which are essentially debt instruments. Companies may also offer investors the opportunity to become co-owners of their business. In such cases, issuers issue shares of stock, which grant buyers the right to a share of the company’s profits (dividends) and, in certain cases, participation in its management. Financial instruments provide investors with the opportunity to invest their funds and generate returns, while issuers gain access to the necessary resources for development and financing their projects.

Where are securities held?

Today, all stocks and bonds traded on exchanges exist in digital form, without physical certificates. When an issuer issues these securities, a registrar creates a registry of shareholders or bondholders on their server and manages it by keeping it updated. This registry contains information about who owns how many securities.

These registries help issuers communicate important information to shareholders, such as dates of general meetings, and distribute dividends for stocks and coupons for bonds. The creators of a company may choose to retain some of the shares or bonds and continue to store them with the registrar. However, trading on the exchange is only possible through the depository system, which records all transactions on the exchanges. This system includes the central depository of the country, exchange depositories, as well as depositories of brokers and asset managers.

The central depository stores securities of companies listed on any exchange worldwide. If you plan to buy and sell securities on the exchange, you need to open a depository account with one of these depositories. However, people often choose to open an account with their broker or asset manager’s depository to avoid additional fees for transferring assets between their account and the intermediary. All the securities you purchase on the exchange will be reflected in your depository account, but they will be physically stored in the central depository of the country.

It is also possible to store purchased stocks and bonds with the registrar of the company that issued them. To do this, you need to open a nominal (face-value) account with the registrar and transfer the securities from your depository account. By doing so, your broker will not have access to these securities, even if you give them permission to manage your other assets. Additionally, in the event of your broker’s bankruptcy, you will not lose the securities held by the registrar.

This method of storing stocks and bonds is suitable for securities that you do not plan to sell in the near future. When you decide to sell them, you will need to transfer the assets back from the registrar’s account to the depository.

To facilitate transactions with foreign securities, exchange depositories open accounts in international settlement depositories. For example, if you buy shares of an American company, they will be physically held in the central depository of the United States, but your depository will show that you are the owner.

Who controls the order in the stock market and stock exchange?

This role is fulfilled by a regulator, a governmental organization that oversees the operations of all professional participants in the stock market, including brokers, asset managers, registrars, depositories, and exchanges.

In the market, the responsibility for these functions lies with the Central Bank of your country. They grant special licenses to all professional market participants.

It is crucial not to entrust your money and assets to intermediaries without the required licenses. If your rights are violated by illegal entities, the regulator will be unable to protect you. In such cases, your only recourse would be to seek assistance from the police, prosecutor’s office, and the judiciary.

When entering into agreements with foreign companies, the Central Bank of your country cannot provide assistance in the event of issues or disputes. To safeguard your interests, you would need to approach the foreign regulator and the law enforcement agencies of the country where the company is registered.

I want to trade on the stock exchange. Where to begin?

It is important to remember that investments in securities always carry the risk of losses. Therefore, becoming an investor is advisable only if you have disposable funds and are willing to take risks.

Buying and selling securities is not akin to gambling or a lottery; it requires meticulous analysis and calculation.

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