It\u2019s that time of year again when many of us have interns joining the desk. So, over the next few weeks, we\u2019ll update our guides on trading, exchange-traded funds (ETFs) and options. Plan your Fridays accordingly!<\/p>\n
As always, we\u2019ll include links<\/a> to additional research for interns looking to take a deeper dive into any of the topics mentioned.<\/p>\n If you\u2019ve worked in the market for years, we know you know all of this. Just enjoy the refresher \u2014 you never know when an intern might ask a question about the basics.<\/p>\n All markets, even the ones you shop in for groceries, have a pretty simple underlying purpose: to bring together buyers and sellers. Doing trade in a centralized way allows consumers to compare prices and producers to advertise to more customers at once. Economically, it\u2019s a win-win.<\/p>\n Stock markets add another dimension<\/a> as they also provide companies with access to investors. Cash from investors allows companies to invest in their businesses and, ultimately, grow profits, which in turn provides income back to the investors.<\/p>\n Whether centralized or not, markets work best with a diverse ecosystem of participants, each with their own specialized role to play in buying, selling and valuing stocks.<\/p>\n Investors provide capital to companies, which then provide dividends and returns to investors. Banks help investors value stocks, while exchanges allow traders to provide liquidity and arbitrageurs to correct mispricings. This all happens at the same prices despite the different trade signals and lengths of time they hold shares.\u00a0<\/p>\n For example, an arbitrageur might see ETFs dislocate from stock values for a few seconds, but a mutual fund portfolio manager may decide to buy a stock to hold for two years based on expected growth in sales.<\/p>\n Chart 1: The stock market ecosystem<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Listing exchanges play a central role in stock markets, literally. They list companies, help traders buy and sell their stocks, and share prices with other investors and analysts.<\/p>\n Listing exchanges also have listing standards, which work alongside the U.S. Securities and Exchange Commision\u2019s (SEC) rules that require corporates to share quarterly accounting statements and other disclosures. That makes stock markets more transparent and relatively safer for investors. That\u2019s why pension and mutual funds often only invest in so-called \u201clisted\u201d stocks.<\/p>\n There are around 5,500 companies and over 3,000 ETFs that are traded in the U.S.\u00a0<\/p>\n Where a stock is \u201clisted\u201d affects what \u201ctape<\/a>\u201d its prices and trades are reported on. There are historic reasons for that. In the past, trades were literally printed onto paper \u201cticker tape\u201d from the location where trades were happening. Today, there are still three \u201ctapes\u201d that publish trades and prices:<\/p>\n Chart 2: Number of U.S. companies on each \u201ctape\u201d<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Index providers use the primary listing exchange\u2019s closing auction<\/a> to calculate the last \u201cofficial\u201d trade of the day. That makes the closing auction for the primary<\/a> exchange important for matching liquidity and minimizing volatility. It’s also important for mutual funds that use the close to calculate unit prices used to invest customer cash flows.<\/p>\n Although only a few exchanges list stocks, all exchanges can trade stocks, and all are required to be open to everyone. Another thing that all exchanges do is to advertise prices<\/a> to everyone.\u00a0<\/p>\n Public prices help buyers find sellers and trade at the best prices in the market. They also help non-traders value portfolios and let portfolio managers buy dips and sell peaks. Competition for the best prices also creates tighter spreads<\/a> that reduce transaction costs<\/a> for all investors (even those who don\u2019t trade on an exchange).<\/p>\n That provides what economists call \u201cpositive externalities.\u201d Everyone benefits \u2013 even those who aren\u2019t trading.\u00a0<\/p>\n Companies, also called \u201cissuers\u201d because they issue stocks, are critical to public markets and to the U.S. economy<\/a>. Without issuers joining public markets, there would be no companies for the public to invest in<\/a>, no dividends for investors, and fewer ways to hedge and trade.<\/p>\n Investors then benefit from dividends and capital gains, which are generated primarily by earnings growth<\/a>.<\/p>\n Chart 3: Stock prices align with earnings<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n The day of an initial public offering (IPO) is important for a company, too. Raising cash can allow a company to grow. Having a stock that trades also makes it easier to issue more shares (in a \u201csecondary\u201d raising) in the future. That makes it easier to invest in equipment and workers \u2013 growing revenues and the economy.<\/p>\n Interestingly, IPO activity rises and falls based on several economic factors<\/a>. IPOs also represent an opportunity for investors to benefit<\/a> from the liquidity premium that public trading adds to a stock. On average, day-one returns for IPOs are positive<\/a>.<\/p>\n Importantly, U.S. stock markets aren\u2019t the only place new companies can find investors. Our listed markets compete with private markets<\/a>, OTC markets (formerly including pink-sheet and bulletin board stocks) and international stock markets for listings.<\/p>\n That said, the U.S. stock market is attractive to issuers. It has the largest source of equity capital, stronger valuations<\/a>, the lowest trading costs<\/a> and, arguably, the most liquidity<\/a> in the world.<\/p>\n In order to raise capital, issuers need to attract investors. Long-term investors<\/a> come in two main flavors:\u00a0<\/p>\n Data suggests they both have roughly the same amount of capital to invest (roughly $20 trillion each).<\/p>\n Chart 4: Who owns shares (based on year-end 2024 data)\u00a0<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n All investors are trying to maximize their investment returns. Many mutual funds will research stocks to try to find companies that will grow revenues<\/a> the fastest, pay the best dividends, have the best profit margins, or offer the best value (however you define that<\/a>).\u00a0<\/p>\n These funds and the professionals managing them provide an important role in what we call \u201cprice discovery.\u201d Their buying makes good companies’ prices go up, while companies with less rosy outlooks see their prices fall as investors sell. It is part of what helps markets efficiently allocate capital. However, actively picking stocks that outperform is also how portfolio managers try to beat the market.<\/p>\n Other portfolio managers run index funds<\/a>. These try to buy every stock in an index, usually at market weight. These funds save costs, as they do less research and much less trading<\/a>. They are also relying on the market’s overall efficiency to ensure the prices they pay are not inefficient.\u00a0<\/p>\n Data comparing returns of index and active funds suggests the market is very efficient. Recent data also shows that the assets in index funds are now larger than those in actively managed mutual funds.<\/p>\n Retail investors also want to maximize investment returns, or at least minimize losses<\/a>. As app-based trading and commission-free trading has made it easier for retail to trade than ever before, retail trading has also grown<\/a>. One thing the data shows is that although retail trade stocks more, they are consistently net buyers of ETFs<\/a>, a form of mutual fund that trades on exchange.<\/p>\n Most of the time, issuers and investors need banks and brokers to help them enter and exit the market.\u00a0<\/p>\n Banks have many direct relationships with issuers and mutual funds. They often lend to companies. They also research companies and execute trades for mutual funds, sometimes using their own alternative trading systems<\/a> (ATSs), such as dark pools. So, they contribute to both capital formation and liquidity.<\/p>\n Ahead of an IPO, brokers will canvass investors to assess interest, help price and allocate shares in the IPO. The IPO is known as a primary market.\u00a0<\/p>\n Then, as investors buy and sell stocks to change their portfolio holdings in so-called \u201csecondary\u201d markets, they usually need brokers to \u201cwork<\/a>\u201d their orders over time.<\/p>\n There is not always another investor looking to sell when a new investor wants to buy. That\u2019s where short-term traders \u2013 from hedge funds and banks to market makers and arbitrageurs \u2013 help.\u00a0<\/p>\n Although each has different investment objectives, they all play a critical role in keeping markets efficient and liquidity cheap. Our estimates also suggest they make up the majority of trading<\/a> (Chart 5).<\/p>\n Chart 5: Investors have the majority of assets; intermediaries do the majority of trading<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Market makers don\u2019t hold stocks for long, but their specialty is being both a buyer and seller at the same time. Creating a \u201ctwo-sided market<\/a>\u201d in each stock ensures investors can trade regardless of whether they are looking to buy or sell. In return, market makers hope to earn the spread<\/a>, or the difference between the bid and the offer.<\/p>\n Arbitrageurs help futures and options track their underlying asset prices very well. Our research shows that ETFs trade in line<\/a> with their portfolios\u2019 net asset values even if the ETF doesn\u2019t trade. Thanks to sophisticated statistical hedging strategies, many ETFs are actually cheaper to trade<\/a> than their underlying stocks.<\/p>\n Hedge funds, in contrast, tend to hold long and short positions<\/a> at the same time. Their strategies often keep similar stocks, sometimes called pairs, efficiently valued. That helps keep markets more efficient, adding selling to a buyer of one stock by buying a hedge from a seller of another stock. Research even shows that short sellers help keep markets efficient<\/a> by adding sellers to overbought stocks<\/a>.<\/p>\n Stock markets have rallied and crashed multiple times in history. Often, following bear markets, rules are changed to protect investors. That\u2019s exactly what happened after the largest bear market in U.S. history, which followed the Great Depression in the U.S., where stocks fell over 85% from their highs as unemployment reached 24.9%.<\/p>\n In the decade that followed the Great Depression, U.S. markets saw the introduction of a number of new rules to protect investors:<\/p>\n Chart 6: Market rises and falls (log scale)<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Another significant regulatory change happened in 1975 with the Securities Act Amendments. Those rules set up what we now call the National Market System (NMS). Perhaps most importantly, brokerage commission rates were deregulated<\/a> by the SEC, a move that drew significant criticism as Wall Street cried May Day<\/a>. However, in a trend that would play out again over the following decades, lower costs led to rising volume that <\/strong>has long since made up for lower fees.<\/p>\n Then, in 1994, Congress passed the Unlisted Trading Privileges Act of 1994<\/a>, which allowed any exchange to trade any ticker\u2014regardless of where that stock was listed. Today, there are 16 exchanges and more than two dozen dark pools, all of which<\/a> can trade any listed U.S. stock. There is also a rise in \u201coff-exchange\u201d trading<\/a>, which includes dark pools, retail trading, and bilateral trading.<\/p>\n Although Instinet launched the first dark pool in 1986, Reg ATS didn\u2019t set consistent rules for dark pools to trade in until 1999.<\/p>\n Chart 7: Today’s market is fragmented, with many venues able to trade any stocks they want<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n It probably seems hard for an intern to believe, but as recently as the 1990s, most stocks were traded in person, in \u201cpits\u201d or at \u201cposts\u201d on the floor of an exchange, with each trade written down on tiny pieces of paper that were taken back to the office to be processed for customers. The next day, interns would probably join \u201crunners,\u201d delivering physical stock certificates from the seller’s broker to the buyer’s broker.<\/p>\n Some floors do still exist today, but the U.S. market started to automate back in 1971<\/a>, an event that ultimately created Nasdaq. Although Nasdaq\u2019s first \u201cdata centers\u201d had tape drives, monochrome cathode tube screens, sideburns and plaid trousers. A lot has changed since then.<\/p>\n Exhibit 1: A Nasdaq data center in 1971, the year the company\u2019s electronic exchange began operating<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n With most floor-based markets, all investors would see was a ticker tape of historic trades, literally a rolled-up piece of paper with typing on it, well after the trades had actually happened. Even today, the industry refers informally to the record of all quotes and trades as \u201cthe tape.\u201d You might even hear a trader still say a trade has \u201chit the tape,\u201d which means it is now on the screen and in the database.<\/p>\n In its first iteration, the National Association of Securities Dealers (NASD, now FINRA) built a system for market makers in OTC (generally micro-cap) stocks to electronically update their bid\/ask quotes. That became the NASD Automated Quotations (hence the acronym NASDAQ).<\/p>\n Exhibit 2: One of the early Bunker-Ramo computer terminals used to make and see quotes<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Over time, as computers improved, more data could be shared more easily. This benefited investors and traders who could not necessarily see what was happening on other human trading floors.<\/p>\n The main data innovation in the 1980s was the creation of a real-time \u201cLevel 2\u201d data feed. More than simply providing the best bid and offer, Level 2 showed all market maker quotes at different prices below the bid and above the offer. What is now called \u201cdepth.\u201d<\/p>\n Exhibit 3: The quote montage from<\/strong> the Nasdaq Workstation II in the late 1990s, showing depth (Note prices are in fractions of a dollar; some bonds still trade in fractions today)<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Another big market crash happened in 1987 when the S&P 500 fell more than 20% in one day. Back then, there were no market-wide circuit breakers<\/a> or other guardrails<\/a> to slow markets down and allow buyers to assemble.<\/p>\n In the aftermath, it was discovered that many market makers were unable or unwilling to trade even though buy prices could be seen on the screens. Shortly after, the process of matching trades was also automated, creating what we now call \u201cactionable quotes.\u201d Although in their early forms:<\/p>\n However, that set the scene for a market that looks more like what we know today \u2013 where almost all trades are executed electronically. And as the market adopted computerized trading, important new rules were introduced:<\/p>\n As a result, market-making became more automated, and trading became cheaper. From 1995 to 2005, markets saw spreads decline 90%, and liquidity increased tenfold. Interestingly, this all happened before<\/em> Reg NMS was implemented in 2007.<\/p>\n Chart 8: The impact of market-wide automation cut trading costs and boosted liquidity<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n Because spreads are so tight, and trades are all reported electronically now, newer SEC rules have been focused on changing ticks<\/a> once more, as well as adding more<\/a> data and smaller trades to public feeds.<\/p>\n This all means that over the past 50 years, trading has gone from human speed to computer speed<\/a> to the speed of light<\/a>. Although for any interns working in electronic trading, it might be important to know that light travels faster in air than in optic fiber<\/a>.<\/p>\n Computerized trading has led to fewer manual errors, faster processing and cheaper trading. It has also made trading faster. A lot faster<\/a>.\u00a0<\/p>\n In reality, almost all trading in U.S. stocks is done in data centers in New Jersey these days. At the speed of light, it takes trades about 0.0002 seconds, or less than 0.2ms<\/a>, to travel from one exchange to another. To put that in perspective, a human blink takes around a quarter of a second (that\u2019s 250 milliseconds).\u00a0<\/p>\n All of this is to say that arbitrage happens very quickly, and markets are now very efficient.<\/p>\n Chart 9: Distances between trading centers at the speed of light<\/strong><\/p>\n <\/source><\/source><\/source><\/picture>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n In the U.S., a series of centralized computers, called the SIPs,<\/a> puts all the fragmented quotes back together<\/a>.\u00a0<\/p>\n The SIPs receive the best bid and offer from all the exchanges for every stock in the market. It then sorts them to find which exchange has the best bid and which exchange has the best offer. Then it creates a single unified national best bid and offer (NBBO<\/a>), which is made available to all investors<\/a>.\u00a0<\/p>\n These are the \u201ctapes\u201d that we talked about earlier. It also lets investors know what the best price is, and where they need to go to get it.<\/p>\n Chart 10: SIPs compile the NBBO based on all the exchanges\u2019 quotes in a specific security<\/strong><\/p>\nMarkets help match buyers and sellers in an efficient way<\/strong><\/h2>\n
The markets are an ecosystem<\/strong><\/h2>\n
![\"The](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.27.32%E2%80%AFPM.png\")
<\/p>\nListing exchanges bring all participants together<\/strong><\/h2>\n
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![\"Number](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.29.03%E2%80%AFPM.png\")
<\/p>\nIssuers give us tickers to trade and dividends to save<\/strong><\/h2>\n
![\"Stock](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.30.05%E2%80%AFPM.png\")
<\/p>\nIssuers need investors<\/strong><\/h2>\n
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![\"Who](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.31.08%E2%80%AFPM.png\")
<\/p>\nIssuers and investors need banks and brokers<\/strong><\/h2>\n
Investors need shorter-term traders to keep markets efficient<\/strong><\/h2>\n
![\"Investors](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.32.09%E2%80%AFPM.png\")
<\/p>\nMarket rules have evolved over time<\/strong><\/h2>\n
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![\"Market](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.33.20%E2%80%AFPM.png\")
<\/p>\nSetting up for fragmentation of liquidity and trading<\/strong><\/h2>\n
![\"Today's](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/06\/image%20%284%29.png\")
<\/p>\nMarket automation also started in the \u201870s<\/strong><\/h2>\n
![\"Nasdaq\"](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2021\/02\/11\/Screen%20Shot%202021-02-11%20at%202.28.27%20PM.png\")
<\/p>\nMoving from automated quotes to trades<\/strong><\/h2>\n
![\"Bunker](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2021\/02\/11\/Screen%20Shot%202021-02-11%20at%202.28.33%20PM.png\")
<\/p>\n![\"Nasdaq](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2021\/02\/11\/Screen%20Shot%202021-02-11%20at%202.28.40%20PM.png\")
<\/p>\nAutomating executions after the 1987 crash<\/strong><\/h2>\n
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Lower costs drive liquidity and activity into the 2000s<\/strong><\/h2>\n
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![\"The](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.40.30%E2%80%AFPM.png\")
<\/p>\nTrading at the speed of light<\/strong><\/h2>\n
![\"Distances](\"https:\/\/www.nasdaq.com\/sites\/acquia.prod\/files\/2025\/06\/05\/Screenshot%202025-06-05%20at%205.43.42%E2%80%AFPM.png\")
<\/p>\nWhere do public prices come from?<\/strong><\/h2>\n