How Exchanges Work for Beginners (Exchanges 101)
If you can’t explain it simply, you don’t understand it well enough. This is especially true with respect to financial markets. When you get to the bottom of it, it’s really simple and easy to understand.
People just make it more difficult by using jargon like ‘bulls & bears’ and candlesticks, which I will completely avoid in this article. Also, I will try avoiding any words that a 5th-grade math student might find difficult.
What’s the first thing that comes to your mind when you picture financial markets? It’s probably that section on the bottom of new channels where the stocks prices are shown in green or red, the newspaper article on how the stock market is crashing, the dollar is weakening, or maybe a conversation with an uncle on how you should invest in gold because its price is rising. All of these examples beg 3 simple questions~ WHAT does price mean? HOW is the price determined? and HOW do exchanges work?
What is Price and who decides it?
Price is simply the value of something in terms of something else — the price of gold in dollars, the price of dollars in euros, and the price of a stock in that country’s local currency. Using the Gold/Dollar example, the price is determined by what people are willing to buy and sell Gold for Dollars. In order words, ‘price’ is determined by demand and supply — not by any individual or group. There are many factors that affect demand and supply, but that’s getting ahead of ourselves.
Exchanges: how they work
An exchange matches people who want to buy and sell something for something else. Continuing with the gold analogy, buyers say what price, in terms of Dollars, they are willing to buy gold, by placing a ‘buy order’. If there is a ‘sell order’ at the same price, then the exchange matches these two orders, a trade happens and the Gold & Dollars change hands. This is now the ‘Last Traded Price’ and THIS is the number that you see on your TV screens when you turn on the news channel.
When the next person places an order, the exchange again checks if there is a matching order on the other ‘side’ (buy or sell), and so the Last Traded Price changes with each successive trade. A quick side note, if there isn’t an order at the same or better price (higher is better on the buy side and lower is better on the sell side, by common sense), then this order stays ‘open’, until a future order matches against it (or is canceled by the person who placed it).
Adding ‘Amount’ to the picture
The amount of gold that gets traded in that trade is the lower amount of the existing and new order, again by common sense. The order with the lesser amount gets fully executed, and the remaining amount of the other order gets matched against a future order.
How to know when to buy or sell?
There’s no easy answer to this. If there was, I’d probably be on a beach somewhere and not writing this. It’s something that only gets better with practice. The goal is to make more good trades than bad trades on average. No one can get it right all the time.
Still, there are a few things any decent trader would recommend. First, understand what you are trading in; if its cryptocurrency, there are plenty of articles (I prefer YouTube videos) out there to give you all the information that you need. Many cryptocurrency exchanges, including ours, have a ‘View Exchange’ option so you can observe it and get familiar without having to create an account. Also, read up on basic strategies and speak to people who have experience trading. Only once you are comfortable, start trading with small amounts. Remember that everyone starts off as a beginner and, with practice, you can get better over time.
To sum up
This, in a nutshell, is how every single exchange works, be it a stock exchange, currency exchange, commodity exchange or cryptocurrency exchange; be it in the US or India or anywhere else.
- Financial markets, the price of assets, and exchanges are really simple at their core
- Price is the value of something in terms of something else, for example, gold in dollars. It’s simply the price at which a buyer and a seller are willing to make a trade
- Exchanges match new orders against existing open ones on the other ‘side’
- As more orders come in and get matched, the last traded price changes and so we get our familiar graph that goes up and down.
