Session 2 How Exchanges Work (NSE, BSE, NYSE, NASDAQ)
What Is a Stock Exchange?
A stock exchange is a regulated marketplace where financial instruments such as stocks, bonds, ETFs, and derivatives are bought and sold. It connects buyers and sellers and ensures that trades are executed fairly, transparently, and efficiently. Retail investors cannot send orders directly to exchanges like NSE, BSE, NYSE, or NASDAQ; instead, they access the market through brokers, who are authorized members of the exchange.
Key Functions of an Exchange
1. Facilitating Trades
How buy & sell orders are matched
🖥️ Electronic Matching Engine
📚 Central Order Book (A central order book is a live electronic list of all buy and sell orders for a stock on an exchange. It shows who wants to buy, who wants to sell, at what price, and in what quantity. Orders are matched using price and time priority, and unmatched orders wait in the book until a match is found.)
🎯 Price–Time Priority
⚡ Automatic execution in milliseconds
2. Price Discovery
How prices are decided
⬆️ More buyers → Prices rise
⬇️ More sellers → Prices fall
💬 Continuous competition between buyers & sellers
📌 Last traded price = market price
3. Liquidity
How easy buying & selling is ensured
👥 Large number of participants
🤝 Market makers provide constant buy & sell quotes
🚀 Fast electronic trading systems
📉 Narrow bid–ask spreads
Bid-ask spread: the difference between:
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Bid price → highest price a buyer is willing to pay
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Ask price → lowest price a seller is willing to accept
Why should we know about the bid-ask spread?
A) Cost of trading
Imagine a stock:
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Bid price (buyers want) = £100
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Ask price (sellers want) = £100.20
You want to buy:
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You pay the ask price → £100.20
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If you immediately sell, you get the bid price → £100
💡 Difference = £0.20 → this is the spread, your “hidden cost” even if your broker charges zero fees.
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Smaller spread = less difference → cheaper to trade
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Larger spread = more costly, harder to make profit
📌 Smaller spread = cheaper to trade
B) Liquidity
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Narrow spread → highly liquid stock (many buyers & sellers)
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Wide spread → low liquidity or higher risk
📌 Traders prefer liquid stocks because they can enter and exit easily.
C) Execution Quality
Execution quality = how close the actual trade price is to what you expected.
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If you place a market order (buy/sell immediately at current price):
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Buy → you pay the ask
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Sell → you receive the bid
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Wider spreads = bigger gap between what you pay and what you get → your trade is less “efficient”
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Price slippage happens if:
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Stock is volatile
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Spread is wide
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You place a large order that consumes multiple price levels
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💡 Knowing the spread helps you decide:
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Narrow spread → market order is fine
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Wide spread → use a limit order to avoid paying too much
📌 Knowing the spread helps you choose between market vs limit orders.
4. Regulation & Oversight
How markets stay fair and safe
📜 Strict trading rules
👮 Real-time market surveillance
🚦 Circuit breakers & price limits
🏛️ Supervision by regulators (SEBI, SEC, etc.)
5. Clearing & Settlement
How trades are completed
🧾 Trade confirmation
🏦 Clearing house guarantees the trade
💰 Money transfer + 📄 ownership transfer
⏱️ Settlement in T+1 / T+2 days
How Trading Works
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Investor places an order
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Examples: Buy 100 shares of Company X at market price, Sell 50 shares at £500.
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Order goes to a broker
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Brokers are intermediaries that submit orders to the exchange.
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Exchange matches orders
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Buy and sell orders are matched electronically.
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Trade is executed
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Once matched, the trade happens.
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Clearing & Settlement
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Ownership and money are transferred (settlement period varies by exchange).
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This entire process can happen in milliseconds on electronic exchanges!
Yes, you can place multiple buy and sell orders with different prices in the central order book and let them wait; if the market price eventually matches, the orders will be executed automatically.
You can place a limit order and let it sit in the central order book, waiting until the price matches.
If the market later reaches your price, the order will automatically execute.
However:
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Most retail orders are day orders → they expire at market close if not matched.
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To wait across days, you must place a Good-Till-Cancelled (GTC) or similar order (if your broker/exchange allows it).
So in practice:
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✅ Limit order + valid duration → waits in the order book
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✅ Price matches later → executes automatically
• ❌ No match before expiry → order is cancelled