Some stock exchanges are physical locations where transactions are carried out on a trading floor, by the open outcry method. This type of auction is used in stock and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders at computer terminals. The first kind of stock exchange, where shares are delivered against cash is called a cash market. Here, there is no trading in futures, short selling or options as the physical paper is traded against cash.
As such the older kind of stock exchange offers cash trading as against electronic exchanges where the trading can also be on derivatives.
Earlier, buyers and sellers were individual investors. Over time, stock markets have become more "institutionalized", that is, buyers and sellers are largely institutions such as pension funds, insurance companies, mutual funds, hedge funds, investor groups, and banks. The rise of the institutional investor has led to some improvements in market operations. For instance, ``fixed’’ (and high) fees being markedly reduced for the ``small’’ investor, but only after the large institutions had managed to break the brokers' solid front on fees.
The Dutch started joint stock companies, which let shareholders invest in business ventures and get a share of their profits – or losses. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds.
The Amsterdam Stock Exchange is also said to have been the first stock exchange to introduce continuous trade in the early 17th century. There are now stock markets in almost all developed and most developing economies, with the world’s biggest markets being in the United States, Canada, China (Hong Kong), India, the UK, Germany, France and Japan.
The stock market is one of the most important ways by which companies raise money by allowing businesses to go public, or raise additional capital for expansion. A stock exchange offers liquidity to the investor who can quickly and easily sell the scrips they hold.
History has shown that the price of shares is an important part of the dynamics of economic activity, and can both influence and be an indicator of social mood. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect household consumption.
Investors may temporarily pull stock prices away from their long term trend level. Over-reactions may occur — so that excessive optimism may drive prices unduly high or excessive pessimism may drive prices unduly low. New theoretical and empirical arguments have been put forward against the notion that financial markets are efficient.
According to the efficient market hypothesis (EMH), only changes in fundamental factors, such as profits or dividends, ought to affect share prices. However, this hypothesis is tested by such events as the stock market crash in 1987, when the Dow Jones index plummeted 22.6 percent — the largest-ever one-day fall in the US.