Exchange definition

What is an exchange?

An exchange is an open, organised marketplace for commodities, stocks, securities, derivatives and other financial instruments. The terms exchange and market are often used interchangeably, as they both describe an environment in which listed products can be traded.

A key function of an exchange is to provide fair, efficient and orderly trading opportunities by centralising the buying and selling of a particular type of asset. Instead of dealing directly with exchanges, most traders will use a broker.

Pros and cons of exchanges

Pros of exchanges

Exchanges are regulated bodies which means transparency of both pricing and transactions. According to these regulations, every trade on an exchange is guaranteed and settled, usually through a clearing house. Exchanges also have a responsibility to ensure best execution – which means that all participants get equal treatment and all trades are executed at the best available market price.

Cons of exchanges

As transactions are often spread across multiple exchanges, there has been an increase in algorithmic trading and high frequency trading (HFT) models. There has been speculation that these models can provide false liquidity and front-running – which is the practice of illegally executing a personal order ahead of a sizeable client order. In instances when the algorithms trade outside of their expected patterns, these models have also been linked with market crashes.