Stock Basics · Lesson 2/7 · 4 min read
How the Stock Market Actually Works
An Exchange Is Just a Marketplace Where Stocks Change Hands
Think of a stock exchange as an online marketplace where buyers and sellers meet. The major ones:
- United States: NYSE (New York Stock Exchange), Nasdaq
- South Korea: KOSPI (large caps), KOSDAQ (small/mid caps and growth stocks)
The exchange itself isn't a company you invest in — it's infrastructure that makes sure trades get matched fairly. Individual investors don't place orders directly on the exchange; you place an order through a broker, and the broker routes it to the exchange.
How Orders Get Matched: The Order Book
The core of any exchange is the order book. It's a running list of "I want to buy at this price" (bids) and "I want to sell at this price" (asks), stacked by price.
Asks (sellers)
$51.00 120 shares
$50.90 340 shares
$50.80 85 shares ← lowest ask
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$50.70 200 shares ← highest bid
$50.60 150 shares
$50.50 90 shares
Bids (buyers)
In this example, there's a $0.10 gap between the lowest ask ($50.80) and the highest bid ($50.70), so no trade has happened yet. The moment someone places a buy order at $50.80, or a sell order at $50.70, a trade executes at that price.
💡 Understanding this explains why you can't always buy at exactly the price you want — someone on the other side has to actually be willing to trade at that price.
Matching Rules: Price Priority, Then Time Priority
Exchanges decide which order executes first using two rules:
- Price priority: For buy orders, the highest bid gets matched first. For sell orders, the lowest ask gets matched first. (Buyers who are willing to pay more get priority; sellers willing to accept less get priority.)
- Time priority: At the same price, whoever placed the order first gets matched first.
Who's Actually Trading
A wide range of participants fill up the order book:
- Retail investors: Individuals like you
- Institutional investors: Pension funds, asset managers, insurance companies — professional investors managing large pools of capital
- Foreign investors: Capital flowing in from overseas
- Market makers / algorithmic traders: Continuously provide liquidity to the order book and profit from the bid-ask spread
Headlines like "foreign and institutional investors were net buyers today, while retail was a net seller" are describing capital flows across exactly these participant groups.
Market Hours
| Regular session hours | |
|---|---|
| US (Nasdaq / NYSE) | 9:30 AM – 4:00 PM ET |
| South Korea (KOSPI/KOSDAQ) | 9:00 AM – 3:30 PM KST |
US markets also have pre-market and after-hours sessions outside regular hours, so some trading is possible then too — but volume is thin, which means prices can swing more. If you're new to investing, it's best to trade during regular session hours.
Indexes: The Market's Overall Temperature
When people talk about "the market" moving up or down, rather than a specific stock, they're talking about an index.
- S&P 500: A representative index of 500 large US companies
- Nasdaq Composite: A tech-heavy index of stocks listed on the Nasdaq
- KOSPI Index: A market-cap-weighted index of major companies listed on KOSPI
Even a strong individual stock can get dragged down if the overall market (the index) is in a downtrend. That's why many investors check the broader index trend before diving into individual stock analysis.
The Spread Is a Hidden Trading Cost
The gap between the highest bid and the lowest ask in the order book is called the spread. It never shows up on a statement like a commission does, but it's a real cost you pay as an investor.
For example, if a stock's highest bid is $9.98 and lowest ask is $10.00, and you hypothetically bought at market and immediately sold back at market, you'd lose $0.02 (0.2%) for nothing. For large, liquid stocks, this spread is typically very tight — 0.01% to 0.1%. For thinly traded small caps, it can widen to 1–3% or more.
💡 The more frequently you trade short-term, the more this spread cost compounds and eats into your returns. If your strategy involves trading multiple times a day, always check how tight a stock's typical spread actually is.
Why Do Market Makers Exist
Participants who continuously post both bid and ask orders in the order book are called market makers, or liquidity providers. They're not betting on direction — they profit from the spread itself, buying at $9.98 and selling at $10.00 thousands of times a day and pocketing the accumulated difference.
The more active the market makers on a stock, the tighter the spread and the smoother the execution. Conversely, small caps and low-liquidity stocks that draw less market maker interest tend to have wider spreads, where a single large order can move the price significantly. This is also the answer to "why does buying even a small amount of this stock move the price so much."
Summary
- Exchanges connect buyers and sellers; individuals place orders through a broker.
- Orders in the order book get matched by price priority, then time priority.
- Market participants include retail, institutional, and foreign investors, and their capital flows are frequently covered in financial news.
- Indexes act as a thermometer for the overall direction of the market.
In the next lesson, we'll cover the different types of orders — market, limit, and stop orders — that you'll actually choose from when placing a trade.