How Markets Work · Beginner · 5 min

What is an exchange?

You can explain what an exchange does and follow an order from your app through the broker and the exchange to clearing.

Where buyers meet sellers

When you press buy in a trading app, it can feel as if the app sells you the share. Usually it doesn't. Your order travels to a marketplace where it meets the orders of thousands of other people: an exchange.

Exchanges are the reason a price on your screen means something. They bring buyers and sellers together in one place, under one set of rules, and publish every trade. Knowing what happens there makes many later topics easier, from spreads to order types.

What an exchange does

An exchange is an organized, regulated marketplace for trading shares and other financial products. In the United States, large stock exchanges such as the New York Stock Exchange and Nasdaq are registered with the SEC as national securities exchanges. In Germany, Deutsche Börse runs Xetra, its electronic trading venue. Today most exchanges are computer systems rather than trading floors.

An exchange has four main jobs:

Listing. Companies apply to have their shares traded there and must keep to the exchange's rules, for example on publishing financial reports.
Matching. The exchange collects buy and sell orders in an order book and matches them. Most stock exchanges match by price first and, at the same price, by time: the earliest order is filled first.
Rules and supervision. Exchanges set and enforce trading rules and are themselves supervised by a government regulator.
Publishing prices. Every trade is reported. The price you see on a chart is a record of those trades.

You cannot send an order to an exchange yourself. Only member firms can, so private traders go through a broker: a firm that passes orders on and holds the account.

After a trade, a clearing house steps in between buyer and seller and makes sure both sides deliver, the seller the shares and the buyer the money. For exchange-traded futures and options, this central clearing also protects against the other side failing to pay.

One order, one trade

Say you want to buy 20 shares of a fictional company. Your app shows a bid of 50.00 and an ask of 50.02.

You place a buy order with your broker.
The broker sends it to the exchange, where it reaches the order book.
The exchange finds the cheapest seller waiting, at 50.02, and matches the two orders. You have bought 20 shares at 50.02, a total of 1,000.40 before fees.
The trade is published, and the chart now shows 50.02 as the last price.
Afterwards, settlement moves the shares to you and the money to the seller. For US shares the standard is one business day after the trade.

Everything up to the trade takes a fraction of a second. The order book in the picture is what the exchange works with: everyone's waiting orders, sorted by price.

Common mistakes

"My app is the market." Most apps pass orders on. Some also trade against their customers or route orders to other venues. It is worth knowing how yours works.
"The chart price is the price I'll get." The chart shows the last trade. Your order fills against the orders waiting now.
"Listed means safe." Listing rules require companies to publish information. They say nothing about whether the share is a good investment.
"Everything in a trading app is traded on an exchange." Many products, such as CFDs and most forex offers, are traded directly with the provider. That is the next lesson.

The takeaway

An exchange brings buyers and sellers together under one set of rules. Your broker is the door, the order book is the room, and the chart is the record.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1What is the main job of an exchange?

An exchange is a marketplace. It collects orders, matches them and publishes the trades. It does not predict prices.
2Tap the step where buy and sell orders are matched.

Tap the chart.

Orders meet in the exchange's order book. The broker passes them on, the clearing house settles the trade afterwards.
3Why do private traders need a broker?

Exchanges only accept orders from their members. A broker passes your order on and keeps your account.
4What does a clearing house do after a trade?

Clearing makes sure the seller delivers the shares and the buyer the money. For futures and options it also protects against a party that fails to pay.

of 4 correct.