What is an Equity Market?
An equity market is a market in which shares are issued and traded, either through exchanges or over-the-counter markets. Also known as the stock market, it is one of the most vital areas of a market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance.
Understanding Equity Markets
Equity markets are the meeting point for buyers and sellers of stocks. The securities traded in the equity market can be either be public stocks, which are those listed on the stock exchange, or privately traded stocks. Often, private stocks are traded through dealers, which is the definition of an over-the-counter market.
Trading in an Equity Market
In the equity market, investors bid for stocks by offering a certain price, and sellers ask for a specific price. When these two prices match, a sale occurs. Often, there are many investors bidding on the same stock. When this occurs, the first investor to place the bid is the first to get the stock. When a buyer will pay any price for the stock, he or she is buying at market value; similarly, when a seller will take any price for the stock, he or she is selling at market value.
Companies sell stocks in order to get capital to grow their businesses. When a company offers stocks on the market, it means the company is publicly traded, and each stock represents a piece of ownership. This appeals to investors, and when a company does well, its investors are rewarded as the value of their stocks rise. The risk comes when a company is not doing well, and its stock value may fall. Stocks can be bought and sold easily and quickly, and the activity surrounding a certain stock impacts its value. For example, when there is high demand to invest in the company, the price of the stock tends to rise, and when many investors want to sell their stocks, the value goes down.
- Equity markets are meeting points for issuers and buyers of stocks in a market economy. They are critical for capital formation and allocation in such economies.
- Stocks can be issued in public markets or private markets. Depending on the type of issue, the venue for trading changes.
The place where stocks in the equity market are traded is the stock exchange. There are many stock exchanges around the world, and they can be either physical places or virtual gathering spots. NASDAQ is an example of a virtual trading post, in which stocks are traded electronically through a network of computers. Electronic stock exchanges often include a market maker, which is a broker-dealer company that both buys and sells stocks in order to facilitate trading for a particular stock. This comes at a risk to the company, but it makes the exchange process for a given stock operate smoothly. Electronic trading posts are becoming more common and a preferred method of trading over physical exchanges.
The New York Stock Exchange (NYSE) on Wall Street is a famous example of a physical stock exchange; however, there is also the option to trade in online exchanges from that location, so it is technically a hybrid market. In a physical exchange, orders are made in open outcry format, which is reminiscent of depictions of Wall Street in the movies: traders shout and display hand signals across the floor in order to place trades. Physical exchanges are made on the trading floor filter through a floor broker, who finds the trading post specialist for that stock to put through the order. Physical exchanges are still very much human environments, although there are a lot of functions performed by computers. Brokers are paid commissions on the stocks they work.
Most large companies have stocks that are listed at multiple stock exchanges throughout the world. However, companies with stocks in the equity market range from large-scale to small, and traders range from big companies to individual investors. Most buyers and sellers tend to prefer trading at larger exchanges, where there are more options and opportunities than at smaller exchanges. However, in recent years, there has been an uptick in the number of exchanges through third-party markets, which bypass the commission of a stock exchange, but pose a greater risk of adverse selection and don't guarantee the payment or delivery of the stock.
The oldest existing stock exchange is the Amsterdam Stock Exchange (AEX), which was founded in the 1600s to trade stocks of the Dutch East India Trading Company, one of the first companies (then called joint-stock companies) to offer shareholder stock. Prior to the AEX, many countries and towns had their own systems of trade regulation that operated much like stock exchanges, but the AEX was the first official stock exchange as we know it. Today, equity markets exist in most developed and developing countries. (For related reading, see "What's the Difference Between the Equity Market and the Stock Market?")