How a Stock Exchange Works

The core of an exchange is a rule for deciding whose order gets filled. Almost every equity venue uses price-time priority: the best-priced order wins, and among orders at the same price the one that arrived first wins.

That single rule produces most of the behaviour traders observe. It is why a large resting order at a round number can absorb selling for a long time before giving way, and why being early to a price matters as much as being right about it. It is also why the queue at a popular level is long: everyone who wants that price has to wait behind everyone who wanted it sooner.

The engine itself is indifferent to who is on either side. It has no view about the company, applies the same rule to a hundred shares and to a hundred thousand, and matches whatever crosses.

The order book is the list of resting limit orders at each price on both sides. The highest price anyone is currently willing to pay is the bid; the lowest anyone will accept is the ask. Between them sits the bid-ask spread, and nothing trades inside it until someone crosses.

In that book the spread is two cents. A market orderMarket orderAn instruction to trade immediately at whatever price is available, guaranteeing a fill but not a price.Read the full explanation to buy 1,200 shares takes the 900 available at 42.10 and then reaches up for 300 more at 42.11, filling at an average of about 42.1025. The screen said 42.10; the fill did not. That difference is where the cost of immediacy shows up, and it grows with the size of the order.

The shape of the book matters as much as the spread. A tight two-cent quote with 900 shares behind it is not the same market as a tight two-cent quote with 90,000 shares behind it, and only the second one can absorb an institutional order without moving.

A market maker is a firm that commits to quoting both sides continuously, so there is always something to trade against. It is compensated by earning the spread across many round trips, and it manages the risk of holding inventory it did not want.

The economics are thin and repetitive. Earning a cent per share thousands of times a day is a real business only if the inventory risk is controlled, and that risk is the probability that whoever just sold to the market maker knew something it did not.

When volatility rises, that risk rises with it, and the rational response is to quote wider and in smaller size. This is why spreads widen exactly when a stock is moving fastest, which feels perverse to a trader who wants to act and is entirely mechanical. Nobody withdrew liquidity to be difficult; the price of providing it went up.

The regular session opens and closes with an auction rather than continuous trading. Orders accumulate over a period, and a single price is chosen that maximises the number of shares that can be matched. Everyone who transacts in the auction gets that same price.

The closing auction in US equities is by far the largest liquidity event of the day, frequently several percent of a stock's entire daily volume in one print. The reason is structural: index fundsIndex fundA fund holding a rules-based basket that tracks a published index rather than picking holdings.Read the full explanation and benchmarked managers are measured against the official close, so transacting at that price is the only way to avoid tracking error.

US equities do not trade in one place. Orders route across a dozen or more exchanges plus a set of off-exchange venues, and regulation requires that an order not be executed at a price worse than the best available elsewhere. The consolidated best prices are published as the NBBO, which is the quote most retail screens display.

Off-exchange execution, sometimes called internalisation, means a share of volume never touches a public order book at all. A wholesaler matches retail orders against its own inventory, frequently at a price slightly better than the NBBO. The trade is reported publicly afterwards but it was never displayed as an available quote.

The proportion of a stock's volume traded off-exchange is disclosed and is a useful read on how much of its activity is actually visible in the book. A name with a very high off-exchange share has a public order book that describes only part of what is happening.

Trading can stop. A regulatory halt pauses a stock pending news so that the information reaches everyone before anyone trades on it. A volatility halt triggers automatically when price moves outside a band in a short window, and lasts a few minutes.

Both matter for anyone holding a position, because a halt removes the ability to act while the reason for wanting to act is still developing. A stop orderStop orderA resting instruction that becomes a live order only once price trades through a trigger level.Read the full explanation does not protect against a halt: it can only execute when the market reopens, at whatever price the reopening auction produces.