From building wealth to planning for the future, stocks can play a role in many financial strategies. Understanding how stocks work is the first step in using them to reach your goals.
A stock is fractional ownership of a company. When you buy stock, you become part owner of the business, along with all the other shareholders.
When a privately held company needs money for expansion or operations, it has several options. It can borrow the money, but that involves taking on debt and paying it back with interest. Or it can issue shares on a stock exchange or in the private markets.
By selling stock, the company gets the funding it needs. By buying stock, shareholders may get a say in how the company runs and own a piece of all future cash flows from the business.
Often, when you own common stock in a business, you get a say in major decisions. For example, you can vote on who sits on the board of directors and whether the company should take part in a merger.
Stocks are bought and sold on a stock exchange such as the New York Stock Exchange (NYSE) and in the private market, where individual and institutional investors can negotiate purchases and sales of company ownership. The “stock market” includes stock exchanges and marketplaces where other investments are traded.
Have you ever wondered who’s on the other end when you click that “buy” button for stocks? I sure did when I first started investing. The answer ain’t as simple as you might think, and understanding this can actually help you become a more confident investor. Let’s dive into the somewhat mysterious world of stock transactions and figure out exactly who takes your money when you buy shares.
The Short Answer: Yes, But It’s Complicated
When you buy stocks you’re generally buying from another investor who’s selling their shares. But the process isn’t as direct as handing cash to someone on the street. There’s a whole system working behind the scenes that most regular folks never see.
As an investor for over 10 years, I’ve come to realize that understanding who’s on the other side of my trades gives me better perspective on market movements. Let’s break this down in simple terms.
The Major Players in Stock Transactions
Before we dive deeper let’s identify who might be selling you those shares
- Individual investors – Regular people like you and me
- Institutional investors – Pension funds, mutual funds, insurance companies
- Market makers – Firms that facilitate trading by always being willing to buy or sell
- High-frequency traders – Companies using algorithms to trade in milliseconds
- Corporate insiders – Executives or employees selling shares they own
- The company itself – Sometimes through new stock offerings
How Stock Exchanges Actually Work
When you place an order to buy stock through your brokerage app, you’re not directly connected to a specific seller. Instead, your order enters a complex matching system.
The stock market works kinda like an auction house, but WAY faster. When you want to buy a stock, your broker sends your order to an exchange where it gets matched with someone wanting to sell. This happens in microseconds these days!
Here’s what typically happens
- You place a buy order for, say, 10 shares of Apple
- Your broker sends this order to an exchange
- The exchange’s computers look for a matching sell order
- When found, the trade is executed
- Ownership of shares transfers to you
- Money transfers to the seller
But wait – there’s more complexity lurking beneath the surface.
The Role of Market Makers: Always Ready to Trade
Market makers are special firms that agree to always provide both buy AND sell prices for specific stocks. They make money on the “spread” – the difference between buy and sell prices.
For example:
- Market maker offers to buy XYZ stock at $9.95 (bid price)
- Market maker offers to sell XYZ stock at $10.00 (ask price)
- They pocket the $0.05 difference per share
This might not sound like much, but multiply it by millions of shares and you see why market making is profitable!
When you buy a stock and there’s no immediate seller, market makers step in. So sometimes, you’re buying directly from them, not another investor.
The Secondary Market vs. Primary Market
Most stock trading happens on what we call the “secondary market” – where existing shares change hands between investors. The company whose stock you’re buying doesn’t actually get your money in these transactions!
The primary market is different. This is where new stocks are issued (like during an IPO). In this case, you would be buying directly from the company, and they would receive your money.
| Market Type | Who Gets Your Money | Who You’re Buying From |
|---|---|---|
| Secondary Market | The seller | Another investor or market maker |
| Primary Market | The company | The company itself |
Dark Pools and Hidden Liquidity
Here’s something most retail investors don’t know about – not all trading happens on public exchanges! Many institutional investors trade in what are called “dark pools” – private exchanges where large blocks of shares change hands without publicly displaying the orders.
Why do they do this? Because showing their hand could move the market price before they complete their large orders. About 40% of all U.S. stock trading volume now happens off public exchanges!
High-Frequency Trading: The Invisible Counterparty
High-frequency traders (HFTs) might be your counterparty without you ever knowing it. These firms use powerful computers and algorithms to make thousands or even millions of trades per day, often holding positions for just seconds or minutes.
They analyze market data and execute trades faster than you can blink. Literally. Sometimes they’re in and out of a position in milliseconds!
According to some estimates, HFTs are involved in more than 50% of all trading volume. So there’s a decent chance you’re buying from one of these algorithmic traders.
Why This Matters For Your Investing
Understanding who you’re buying from can help you make better investment decisions:
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Recognizing market psychology – If you know institutional investors are selling, it might signal something important
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Understanding price movements – Large players can move prices with their trades
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Appreciating liquidity – Market makers ensure you can always buy or sell, even when no natural counterparty exists
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Being realistic about information advantages – Professional traders often have better information and tools than retail investors
Real-World Example: What Happens When You Buy 100 Shares of Apple
Let’s look at a practical example. Say you want to buy 100 shares of Apple (AAPL).
When you place this order through your broker:
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Your broker might route your order to a wholesale market maker like Citadel Securities or Virtu Financial
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These firms might pay your broker for this “order flow” (yep, that’s a thing!)
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The market maker might fill your order from their own inventory
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Or they might route it to an exchange like NASDAQ
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At the exchange, your order could match with:
- A pension fund rebalancing its portfolio
- Another retail investor taking profits
- A high-frequency trader capturing a tiny spread
- An institutional investor reducing exposure to tech stocks
You’ll never know exactly who was on the other side of your trade – and that’s actually okay! The system is designed to be anonymous and efficient.
When Companies Get Involved: Stock Issuances and Buybacks
Sometimes, companies themselves get involved in the market:
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New stock issuances – When companies issue new shares to raise capital, you might be buying directly from the company
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Stock buybacks – When companies repurchase their own shares, they become the buyer
In 2022, companies in the S&P 500 spent over $900 billion buying back their own stock! That means many sellers were actually selling to the companies themselves.
Tips For Retail Investors
Based on understanding who’s on the other side of trades, here are some practical tips:
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Use limit orders – This helps you control the price you pay, especially when trading less liquid stocks where market makers have wider spreads
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Be cautious during low-volume periods – When fewer natural buyers and sellers are in the market, spreads tend to widen
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Watch institutional ownership – Major changes in institutional holdings can signal important information
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Be aware of insider transactions – When executives buy or sell their company’s stock, it might provide insight into the company’s prospects
Common Questions About Stock Transactions
Do I actually own the stock certificate when I buy shares?
In most cases, no. Nowadays, stocks are held in “street name” by your broker. The shares are registered in your broker’s name on your behalf. This electronic system makes trading much faster and more efficient.
Can I choose who to buy my stocks from?
Generally no. The market automatically matches buyers with sellers based on price and time priority. You can’t specifically choose to buy from a particular person or institution.
How do I know I’m getting a fair price?
Regulations require brokers to provide “best execution” – meaning they must try to get you the best available price. Additionally, public exchanges publish all transactions, creating price transparency.
Conclusion: It’s a Complex System That Works Surprisingly Well
So who are you buying stocks from? The answer is: it depends! You might be buying from:
- Another retail investor cashing out for retirement
- A pension fund rebalancing its portfolio
- A market maker providing liquidity
- A high-frequency trading algorithm
- A corporate insider exercising stock options
- The company itself during a new stock offering
The beauty of the modern market system is that you don’t need to worry about finding a specific counterparty. The market does that for you, allowing millions of shares to change hands daily with remarkable efficiency.
Next time you click “buy” on your brokerage app, remember there’s a whole ecosystem working behind the scenes to connect you with a seller, even if you’ll never know exactly who that is.
Understanding this complexity gives you a better appreciation for how markets function and might just make you a more informed investor. After all, knowledge is power when it comes to investing your hard-earned money.
Do you have other questions about how stock markets work? Leave a comment below and I’ll try to answer them in a future article!
How to buy stocks
You can buy or sell stocks by opening a brokerage account through a financial services firm. Your financial advisor can help you get started.
How to manage a stock portfolio
Managing your portfolio is all about your goals and timeline. What are you trying to achieve, and how long do you have to do it?
You’ll often hear financial experts talk about the importance of diversification. This means buying more than one stock, so your risk is spread across multiple industries, geographic regions and market styles. This can help limit losses in your portfolio from the downside in any one industry or sector. There are two important ways to diversify your portfolio:
- Diversify your stock picks — When one of your stocks performs well, you’ll naturally want to buy more just like it. But going too heavily into one company or even one sector can dramatically increase your risk. A sudden dip in that industry can be a blow to your entire portfolio.
- Diversify your investments — Your portfolio should balance stocks with other investments, such as bonds or real estate. A well-balanced portfolio includes a variety of investment vehicles that rise and fall at different times. This can help keep your overall performance steady.
Each stock is just one piece in the engine driving to your goals. Your Edward Jones financial advisor can help you identify not just what to buy, but when to buy and sell. We have the experience to see the big picture. We can help ensure everything in your portfolio works together.
Diversification does not guarantee a profit or protect against loss in declining markets. Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal.