How stock exchanges work

In simple terms

A stock exchange is an organised marketplace where shares of listed companies are bought and sold. In India the two main exchanges are the National Stock Exchange (NSE) and BSE. Today they are entirely electronic: there is no trading floor, only computers matching orders sent from brokers' systems all over the country.

An exchange does four main jobs.

1. Lists companies. A company must meet the exchange's requirements and agree to its disclosure rules before its shares can trade there. This is called listing.
2. Provides the marketplace. It runs the system where buy and sell orders meet, with the same rules for everyone.
3. Matches orders and publishes prices. It matches buyers with sellers and shows the prices and quantities traded, so everyone sees the same information.
4. Supervises trading. It watches for unusual activity and enforces its rules, under the oversight of SEBI.

An exchange does not set share prices and does not buy or sell shares itself. Prices come from what buyers and sellers are willing to do.

How orders are matched

When you place an order through a broker's app, it is sent to the exchange and joins the order book for that share: a live list of every waiting buy order and sell order with its price and quantity.

The exchange matches orders using price-time priority:

• Price first. The buyer willing to pay the most and the seller willing to accept the least are matched first.
• Then time. If two orders have the same price, the one that arrived first is matched first.

You will see how to choose the price on your own orders in Market and limit orders.

The trading day

Each trading day begins with a short pre-open session: a call auction in which orders are collected and a single opening price is worked out from them, which reduces wild swings in the first minutes. Normal continuous trading follows until the market closes. The exchanges publish their trading hours and holiday calendars, and can change them.

Settlement: when the shares are really yours

When your order is matched, the trade has happened, but the shares and money have not yet moved. Settlement is the process of actually transferring the shares into the buyer's demat account and the money to the seller.

Settlement is handled by a clearing corporation attached to the exchange. It stands between buyer and seller and guarantees that the trade will be completed, so you do not need to worry about whether the stranger on the other side will pay or deliver.

Settlement happens a set number of working days after the trade date, written T+1, T+2 and so on, where T is the day of the trade. The settlement cycle is set by SEBI and the exchanges, and it has become shorter over the years as systems have improved. With a T+1 cycle, for example, shares you buy on Monday normally reach your demat account on Tuesday.

Why it matters

Knowing how an exchange works answers questions that puzzle many new investors. Why did my order not go through? Probably because no seller would accept your price. Why did I get a slightly different price from the one on the screen? Because the screen showed the last trade, and the next available seller wanted more. Why are shares I bought today not yet showing in my demat account? Because the trade has not settled yet.

It also explains why trading on a recognised exchange is safer than dealing privately. Everyone trades under the same rules, prices are public, and the clearing corporation guarantees that trades are completed.

Limitations

This lesson describes the normal cash (or "equity") market. Exchanges also run separate segments for derivatives, currencies and bonds, with their own timings and rules. Trading can also be paused: exchanges set price bands for many shares and can halt trading in a share or the whole market under certain conditions.

Exact timings, holidays and settlement details are set by the exchanges and SEBI and can change, so check the exchanges' own websites for the current ones.

Common mistakes

• "The exchange decides the price." The exchange only matches orders. Prices come from what buyers and sellers agree.
• "The last traded price is the price I will get." Your order is matched against whatever orders are waiting when it arrives, which can differ from the last trade.
• "A bigger order gets priority." Priority is by price, then time, not by size.
• "Shares bought today are in my demat account today." They arrive after settlement, a set number of working days after the trade.

Try it yourself

Open any broker app or the NSE website and look at a large company's share during market hours.

1. Find the last traded price, the best buy price (bid) and the best sell price (ask).
2. Note the time. Check again 15 minutes later and see how all three changed.
3. Before normal trading starts on a trading day, look at the same screen during the pre-open session and find the opening price being worked out.

You are not placing any order. The aim is to see the order book and the trading day for yourself.