NASDAQ

What It Means

The NASDAQ stock market is the United States’ largest electronic stock exchange. A stock is a portion of a company’s ownership that can be purchased and sold. The value of a stock rises or falls depending on the company’s performance. This means that people generally want to buy the stocks of companies that perform well and sell the stocks of companies that do not perform well.

Stock exchanges (also called stock markets) are places where the buyers and sellers of stocks come together to make trades. Some stock exchanges, such as the New York Stock Exchange (NYSE), provide physical locations where trading occurs. NASDAQ trades, on the other hand, are processed by computers.

The NASDAQ is commonly associated, in the minds of many, with technology stocks. While many older, more established companies list their stock (make their stock available for trading) on the NYSE, many of the top younger companies, such as Microsoft, Apple, and Google, have chosen to list their stock on the NASDAQ.

When Did It Begin

The NASDAQ stock market opened for trading on February 8, 1971. NASDAQ was originally an acronym for National Association of Securities Dealers Automated Quotations, but the exchange has over time severed its connection to the association of securities dealers that founded it. (A security is a contract that is assigned value so that it may be bought or sold. Stocks are a type of security, as are bonds, which typically represent money that citizens have loaned to the government.) NASDAQ was the world’s first electronic stock exchange. Prior to its introduction, stock trades around the world had to be conducted at a physical location where brokers (people who are authorized to make trades on a given stock exchange) met to negotiate the orders of the buyers and sellers that they represented.

Although the NASDAQ’s trades were always processed electronically, in the exchange’s early years investors still had to use the telephone to place orders for trades. During a stock market crash in 1987 (a crash occurs when many stocks lose value at once, causing a stock exchange to lose a large amount of total value), the people who facilitated trades on the NASDAQ stopped accepting phone calls from small investors, preventing these individuals from trading stocks that were losing value quickly. In response to this breakdown of the NASDAQ system, the exchange established an electronic method for placing orders, allowing individual investors to trade stocks by computer.

More Detailed Information

The fact that the NASDAQ is an electronic stock exchange does not mean that there is no human involvement in the trading process. In fact, the terms of all trades are established by market makers, companies that pay for the right to buy and sell one particular stock on the NASDAQ. They are responsible, each day, for determining the buying and selling prices of that stock. They post a price at which they will be willing to buy the stock and a slightly higher price at which they will be willing to sell that same stock. The difference in the two prices, called the spread, allows them to make a profit.

Market makers enter the buy and sell prices for individual stocks into NASDAQ computers, and investors enter their orders to buy or sell stocks into NASDAQ computers. When investors list buying and selling prices that are in synch with the prices listed by market makers, computers process these orders.

In traditional stock trading, such as the trading that occurs at the NYSE, the people who function as market makers are called specialists. Specialists stand at a certain location on the floor of the exchange and personally process buying and selling orders. But trading using a NASDAQ market maker and trading using a NYSE specialist are different in another important way. The NASDAQ is what is called a dealer exchange, while the NYSE is what is called an auction exchange. On the NASDAQ, market makers are dealers of certain stocks. Investors buy stocks from market makers and sell them to market makers. On the NYSE, specialists function as auctioneers. They set prices so that buyers and sellers can make trades with one another.

Older, well-established, reliable companies, such as Ford Motor Company, General Electric, and IBM, typically list their stocks on the NYSE, whose history dates to 1792 and is closely linked to the rise of the American economy in the nineteenth and twentieth centuries. The NASDAQ, by contrast, typically attracts newer companies with smaller initial assets (the money used to start a business) but large potential for growth. Microsoft, Apple, and Google, all among the United States’ most important corporations in the early twenty-first century, listed their stocks on the NASDAQ. Companies that go public (that allow investors to buy and sell their stock) therefore often consider how they want to be perceived (as stable and reliable or as daring and innovative) before deciding whether to list their stock on the NYSE or the NASDAQ.

Because of its concentration of newer and less stable companies, the NASDAQ is generally considered more volatile, as a whole, than the NYSE. As of 2007 the NASDAQ was listing the stock of more companies than the NYSE (roughly 3,200 versus roughly 2,700). The number of trades conducted on the NASDAQ each day is also usually larger than the number conducted on the NYSE, but the NYSE remains the world’s largest stock market in terms of the value of the stock that is bought and sold there. Together these two stock exchanges are among the most important elements of the U.S. economy.

Recent Trends

For most of the 1990s, there was a bull market for stocks in the United States. A bull market is a period when the stock market as a whole is gaining value and investors are consistently making profits. The 1990s bull market was strongly tied to the rapid growth, starting in approximately 1995, of Internet-related businesses. The general public was becoming increasingly aware of how the Internet operated, and businesses rushed to capitalize on the possibilities for making profits online. This created an environment in which new companies were given huge amounts of financial backing to pursue Internet-related businesses (often called dot-coms).

Many of these companies listed their stock on the NASDAQ, and in some cases dot-com stock prices rose enormously in value even though the companies did little to justify the confidence in their future performance. More and more people rushed to capitalize on the huge increases in technology stock prices. These investors were making unwise stock purchases, betting on stock price increases rather than on actual company performance. The result was what became known, in retrospect, as the dot-com bubble.

A bubble is a period of unsustainable stock-market growth fueled by excess optimism on the part of companies and investors. Stock-market bubbles burst when it becomes clear that the optimism was inaccurate. In the case of the dot-com bubble, this began to happen in the spring of 2000, when the total value of stocks traded on the NASDAQ peaked and began to decline. The NASDAQ perpetuated the dot-com bubble more than any other stock market, and it paid the heaviest price. As of 2007 the total value of the stocks traded on the NASDAQ remained less than half of what it had been before the bubble burst.