How the stock exchange works

The stock market is not as abstract as it may seem to newcomers. The players use a language that at first may sound incomprehensible. But the stock market is nothing more than a marketplace, such as a vegetable market, where traders offer their goods and retailers buy for their customers what they need.

Wholesale market stock exchange

The best way to compare a stock exchange with a wholesale market. Just as on the stock exchange, the actual end consumers and sellers rarely meet directly. Producers sell their goods to wholesalers, where vegetable traders procure their goods. Consumers in turn buy vegetables from traders.

The exchange itself does not trade, nor does the operator of a wholesale market have a stand there. It organises the market, takes care of the rules, provides the infrastructure such as the trading system but also the house, takes care of the supervision, advertises the market place.

For trading itself, the exchange relies on the help of securities trading banks, the market participants in the narrower sense. In a broader sense, the term 'market participant' also includes investors, analysts, journalists, etc.. The producers on the stock exchange are the issuers of the securities, shares and bonds are companies, derivatives are banks.

In the meantime, the transactions are predominantly carried out fully electronically. Stock exchange traders are no longer in direct contact with each other, but a computer system compares the buying and selling wishes.

Market participants: traders, investors and companies

Players on the marketplace are investors (in our wholesale market comparison the end consumers, issuers (the producers) and the traders).

The group of traders includes the specialists on the exchange floor who, like stand operators in the wholesale market, combine the buying and selling orders and thus make the prices

In Xetra trading, bank traders take on this task, who - like a flying vegetable seller - place orders from customers in the electronic trading system. Whether for their own account, for customers or on behalf of issuers, in order to increase the tradability of a security.

Investors and traders

End users are a very heterogeneous group. There are large institutional investors, such as municipal treasurers or insurance companies, mutual funds and asset managers. But there are also private investors with very long-term asset targets and few stocks in their portfolio, equity savers, as well as very active traders with speculative strategies.

Investors have no direct access to the trading system. At the Frankfurt Stock Exchange, access to the trading floor and thus to direct trading has always only been possible for participants with admission to trading. Today, there is no longer any floor trading on the spot anyway. Investors place their orders via a custodian bank or, in the case of some professional investors, via the trading desk of their institution - whether on Xetra or the Frankfurt Stock Exchange. However, online brokers, for example, offer order placement on the Internet via order masks, which are so fast that it hardly differs from direct access to the trading system.

Companies

Just like investors, companies are not to be found on the floor. There "only" the shares of the companies are traded. Nevertheless, for many issuers the listing on the Frankfurt Stock Exchange is an unforgettable highlight in the company's history. The stock exchange atmosphere at the first price fixing in broker-supported floor trading is unique. This experience can be followed live on the Internet during an IPO on the Xetra electronic trading platform.

An IPO opens up many opportunities for companies seeking capital. As a rule, listed companies not only grow faster, they also react more stably to economic fluctuations. In general, an IPO makes sense when it comes to placing companies on a broader equity base.

Unlike debt capital, equity capital is available for an unlimited period of time and increases a company's flexibility. In the long term, it can be used for strategic projects, for example to position the company in international competition, to consistently pursue growth strategies, to increase awareness in the market and among investors, and to promote its attractiveness as an employer.

Company succession can also be regulated through an IPO: The conversion into a stock corporation and a subsequent IPO make the enterprise value transparent and facilitate the separation of ownership and management. An IPO on the Frankfurt Stock Exchange (FWB) keeps all these opportunities open for companies.

Whether an IPO is successful depends not only on the company itself, but also on the market environment. What is the current valuation on the stock market, i.e. where are the prices? Which sectors are receiving particular attention? There are also certain fashions on the stock market. If everyone is still talking about solar energy today, nanotechnology could be the darling of the season tomorrow. How high is investors' liquidity? The IPO industry calls this an open 'window of opportunity' for an IPO.

Corporate Governance – good behaviour of listed companies

Investments require trust – in business models, products, markets and above all in the management of a company. The major global fraud cases in the history of financial markets have made many private investors suspicious and damaged their interest in equity investments. This is one reason for the demand for clear rules of corporate etiquette. The increasingly international orientation of corporations and their investors is another factor. Globalisation requires uniform rules so that companies and their markets can be better compared.

The term corporate governance, which can be translated as corporate management, describes a regulatory framework for the management and supervision of companies. It is above all a question of the legal and actual distribution of tasks between the supervisory board, management board and owners, as well as the remuneration and incentive systems of these bodies.

With the increasing importance of sustainability criteria in investment decisions, governance is once again moving more into the focus of investors. Corporate good conduct is one of the three pillars - in addition to the environment and social responsibility - of sustainable management.

© May 2019 - Deutsche Börse AG