For centuries, a stock market was a physical arena in which buyers met sellers and exchanged shares. Loud, aggressive participants shouted themselves hoarse and sweated through their clothes executing orders in the pit. Until the day NASDAQ opened for business, rendering that model obsolete and introducing a permanent shift in the securities industry to instantaneous speed and freedom from (most) errors. (For more, see: The Death of the Trading Floor.)
So how did a virtual marketplace without a trading floor become what, by some measures, is the largest and/or most powerful stock exchange in the United States?
The National Association of Securities Dealers Automated Quotations, better known by its acronym, is now in its 44th year. NASDAQ remains as groundbreaking a concept as the stock market has seen since the invention of limited liability. Today, 2,906 and counting companies trade between NASDAQ’s imaginary walls, those companies’ total market capitalization amounts to trillions of dollars. (For more, see: How NASDAQ Stock Prices Are Set.)
NASDAQ began in 1971 with a revolutionary idea that now seems so commonplace as to be taken for granted. It was the first stock exchange in North America to, as its name indicates, handle trades electronically. At the time, all the stock exchanges in existence used primitive open outcry – client calls broker, broker calls floor trader, floor trader yells and screams until he finds a corresponding floor trader, then it all gets written up in a ledger book. While that method boasted plenty of drama, its reliance on human power meant it wasn’t exactly productive. (For related reading, see: Are The NYSE Trading Floor's Days Numbered?)
No More Floor
NASDAQ was the first exchange to forgo a trading floor, instead getting by with just a set of electrons moving back and forth. Of course, at this point practically every other exchange in the civilized world has followed suit.
The efficiency that NASDAQ’s electronic system offers is twofold. (Actually, it’s manifold, but a pair of major advantages stick out.) Not only are there fewer links in the chain from order to execution under NASDAQ’s system, but the execution happens far more quickly. Before NASDAQ, a seller offering shares of XYZ at 16 and a buyer bidding at 15 might never meet and negotiate a deal. Today the size of the spread between the prices, and similar relevant information, is instantly available to whoever wants and can use it. And the number of trades made at 15½ is far greater, with more parties walking away happy. (For more, see: What Exactly Is Being Done When Shares Are Bought And Sold?)
Driven By Technology
As NASDAQ grew throughout the 1970s, and in keeping with its status as a technologically advanced exchange, it was the trading place of choice for upstart computer companies, harbingers of a new economy. NASDAQ thus contrasted with legacy players such as its eventual major rival the New York Stock Exchange. At the time, the NYSE was populated by dinosaur businesses; asbestos roofing suppliers, meat packers and the like. Many of the tech companies on NASDAQ came and went in its early days, but a couple of firms’ initial public offerings represented watersheds: those of Apple Inc. (AAPL) in 1980 and Microsoft Corp. (MSFT) in 1986. Microsoft was to become the largest corporation in the world in short order (as Apple would later), forever destroying the notion that the NYSE – and only the NYSE – could represent the apotheosis of corporate success in the United States. (For more, see: Electronic Trading: The NASDAQ vs. The NYSE.)
Investing In NASDAQ
One notable aspect about NASDAQ is that if you’re enamored by its importance, its status, or its profitability, you can invest in it: not merely in its listed issues, but in the exchange itself. NASDAQ is the subsidiary of a corporation, named NASDAQ OMX Group Inc. (The latter initialism derives from the Swedish for “Options Brokers Exchange,” a company that owned several Scandinavian and Baltic stock exchanges. NASDAQ bought OMX in 2007.) The parent trades publicly, and does so on NASDAQ itself — under the symbol "NDAQ."
As a business, NASDAQ does better than most of its listed issues. The company made $385 million on sales of just over $2 billion last year. As to what NASDAQ “sells,” revenues go well beyond charging those 2,906 member companies for the privilege of being listed. A substantial majority of NASDAQ’s earnings come from what the exchange refers to as “market services.” That’s surveillance, analytics, and related number-crunching activities, paid for from fees on the transfer of fixed-income securities, derivatives and plain old equities. (For related reading, see: An Introduction To Stock Market Indexes.)
Practically speaking, what distinguishes NASDAQ most from its predecessors is the existence of its market makers. Every exchange employs market makers – traders willing to come up a bit on the highest extant bid or down on the lowest extant offer in order to facilitate a sale and thus “make a market” – but NASDAQ’s are a different species altogether. Whether serving individual or institutional investors, NASDAQ market makers compete with each other, thus giving buyers and sellers better prices than they’d otherwise get.
The Bottom Line
The stock market is complex beyond any one person’s understanding. The genius of NASDAQ is that thanks to its comprehensive data network (on which it spent $82 million last year), that complexity becomes easily manageable. Thus attracting more and larger companies every year. (For more, see: Getting To Know The Stock Exchanges.)