US Equity Market Structure (3): The Ball – Publicly Listed Stocks

This is the third post of a series on US Equity Market Structure (a total of 6).

I didn't write any of these posts; while I was learning the fundamentals about investment, I came across this series on Interactive Brokers' IBKRCampus. If you are interested you can go to their site here.

（Disclosure: I'm using Interactive Brokers for my personal investing, but I'm not paid by them to write about it.)

This series is mostly platform-agnostic, meaning that you don't have to be on Interactive Brokers to find this series useful. Enjoy.

Welcome back to our introductory course on U.S. equity markets. In our previous lessons, we talked about the rules and regulators of the game, as well as the playing field and referees—the trading venues. Now that we have the structure set up, it's time to dig into what we mean when we say U.S. equities and what we're actually trading—the ball in the game of trading.

As you know, when you buy stock in a company, you aren't buying a concrete object. For example, if you buy a share in a pencil-making company, you can't go to their factory and demand a bunch of pencils or one of their pencil-making machines. Instead, the stock represents an ownership stake in the company, giving you certain rights. For instance, if the company is sold, you generally get part of the purchase price, and you usually get a vote on certain decisions.

What Are U.S. Equities?

In general, when we talk about U.S. equities, we are referring to stocks that are registered with the SEC and listed on one of the U.S. stock exchanges. These stocks are publicly traded, meaning that pretty much anyone can go to their broker and buy a share. This is in contrast to private companies, which often sell shares to private investors, but those shares aren't available to everyone.

There are also some public company stocks that trade only over-the-counter (OTC), usually because they are too small to qualify to list on one of the major exchanges. Those stocks are not considered part of the National Market System (NMS), so we'll set them aside for now.

Most U.S. equities are often called single stocks, meaning they represent an ownership stake in a particular company. There are also equities called exchange-traded products (ETPs) that allow buyers to purchase a share in a set of stocks, often an index, rather than just one company. For instance, if you buy a share of an S&P 500 ETF (SPY), you are really buying fractions of each of the S&P 500 stocks.

Where Stocks Trade

We know from the previous lesson that stocks trade on exchanges and other trading venues. But one thing to keep in mind is that NMS stocks actually trade on all of these exchanges and usually across all other trading venues too. This is a result of Regulation NMS, which we discussed in the first lesson, the regulation that tied all of the exchanges together.

In many cases, people assume that stocks only or predominantly trade on the exchange where they are listed, and in fact, this was the case until a few decades ago. But today, during regular trading days, stocks can be traded across all different venues.

Listings Explained

If stocks can be traded across all of these trading venues, what does it mean to be "listed" on an exchange? Well, a company's listing exchange has three main responsibilities.

First, the listing exchange handles a company's auctions. The most high-profile auction for a company is usually its Initial Public Offering (IPO). Most companies become public through an IPO, which occurs when a private company decides it wants to become publicly traded. There are several advantages to being a publicly listed company: it allows owners to more easily sell their shares, making them more liquid, and it gives the company the option to sell more shares, raising capital that they can invest in the business. It also provides the company with a more liquid currency to acquire other companies or for mergers and acquisitions (M&A).

An IPO allows a company to become publicly traded and raise capital by selling new shares at the same time. In an IPO, the company offers a large number of new shares for sale through a group of brokers known as a syndicate. The night before the stock starts trading publicly, those shares are priced and sold to a set of large investors. The next morning, a big auction is held on the company’s listing exchange, and the company’s stock becomes available for trading moving forward. The listing exchange is responsible for the technology and rules to ensure that the auction is handled fairly and smoothly.

Recently, a few companies, including Spotify and Slack, opted to become public through what is called a "direct listing." In a direct listing, the company still holds a big auction on its first day of trading, but the auction only includes existing shares that shareholders choose to sell, rather than new shares that the company makes available.

But the IPO auction isn’t the only one. Every weekday, there’s an opening auction (typically at 9:30 a.m. Eastern Time) and a closing auction (typically at 4:00 p.m. Eastern Time) for every stock. Before those auctions, brokers submit their orders to the listing exchange, detailing how many shares they want and what price they are willing to pay. The exchange gathers that information and, at the time of the auction, matches buyers and sellers at a single price that allows the most shares to be exchanged.

Second, the listing exchange is responsible for surveillance of its listed stocks. The exchange monitors trading in that stock and refers cases to regulators if there seems to be manipulative activity. The listing exchange can also halt trading in its listed stocks if needed and is in charge of disseminating important data, such as dividend information.

Lastly, the listing exchange provides services to companies to help them navigate the public market. This isn’t required by regulation, but it’s an expected practice in the industry. These services vary depending on the exchange’s particular strengths and the fees they charge for listing.

In our next episode, we’ll talk about who actually trades in the U.S. equity market and how investors and brokers operate.