How stock exchanges work: IPOs, listings, indices, auctions and trading hours

What you will learn

• How an initial public offering (IPO) works and what a listing segment means
• How an auction price is set using the principle of maximum executable volume
• The difference between auctions and continuous trading during the day
• What a stock index measures and the difference between price and performance indices

Explanation

Order types (market, limit, stop) and broker costs are covered in the Trading course ("Brokers, order types and costs"). Here we look at what happens inside the exchange.

Primary and secondary market

The primary market is where new shares are sold for the first time. In an initial public offering (IPO), a company (or its existing owners) offers shares to the public. Banks usually run a book-building process: they publish a price range, collect orders from investors and then set the final offer price. A prospectus approved by the regulator (in Germany, BaFin) must describe the business and its risks. An IPO can include new shares (money goes to the company) and existing shares (money goes to the selling owners). Read which part is which.

After the IPO, the shares trade on the secondary market, the exchange. A listing means the shares are admitted to trading. Exchanges have segments with different transparency duties; at the Frankfurt Stock Exchange, the Prime Standard has stricter reporting rules than the General Standard. The free float is the part of the shares not held by long-term major owners and available for trading.

Auctions

Many exchanges, including Xetra (the electronic trading system of Deutsche Börse), start and end the day with an auction. During a call phase, orders are collected but not executed. Then the exchange calculates one single price at which all matched orders trade. The basic rule is: choose the price at which the largest number of shares can be executed. If several prices give the same volume, the exchange chooses the price with the smallest surplus (unmatched demand or supply). There are further tie-break rules, but the volume rule is the core.

A buy limit order is executable at any price at or below its limit; a sell limit order at any price at or above its limit.

Continuous trading

Between the auctions, continuous trading matches each new order immediately with the best opposite order in the order book, the list of all open buy and sell limit orders. On Xetra, continuous trading for shares runs roughly from 9:00 to 17:30 German time, with an opening auction, an intraday auction around midday and a closing auction. Other venues, such as Börse Frankfurt, Tradegate or the regional exchanges, have different and often longer hours. US exchanges trade roughly 9:30 to 16:00 New York time. Hours and holidays change, so check the current schedule of your venue. Outside the main hours, liquidity is often lower and spreads wider.

Indices

An index is a number that tracks a basket of shares. The DAX contains 40 large German companies (expanded from 30 in 2021) and is weighted by free-float market capitalisation. How index weights are calculated is covered in the course "ETFs, Funds & Long-Term Investing". One detail matters for stock analysis: the DAX is a performance index, meaning dividends are treated as reinvested. A price index ignores dividends. Comparing a single share's price chart with a performance index therefore understates the share's total return if it pays dividends.

Worked example

Hypothetical example: order book at the end of a call phase (all limit orders, simplified tie-break rules):

Step 1: cumulative demand at each price (all buys with a limit at or above the price) and cumulative supply (all sells with a limit at or below the price).

• €9.90: demand 500 + 800 + 700 + 1,000 = 3,000; supply 600 → executable 600
• €10.00: demand 2,000; supply 600 + 700 = 1,300 → executable 1,300
• €10.10: demand 1,300; supply 2,200 → executable 1,300
• €10.20: demand 500; supply 3,000 → executable 500

Step 2: €10.00 and €10.10 both allow 1,300 shares. Surplus at €10.00: 2,000 − 1,300 = 700; at €10.10: 2,200 − 1,300 = 900. The smaller surplus wins: the auction price is €10.00, and 1,300 shares trade. Fees are excluded.

Common mistake

Practice activity

Hypothetical order book. Buys: 400 at €5.30, 600 at €5.20, 500 at €5.10, 800 at €5.00. Sells: 300 at €5.00, 500 at €5.10, 700 at €5.20, 600 at €5.30. Find the auction price and the executed volume.

Key takeaways

• IPOs happen on the primary market; afterwards shares trade between investors on the secondary market.
• An auction sets one price that maximises executed volume, then minimises surplus.
• Trading hours differ by venue; liquidity outside main hours is usually lower.
• Know whether an index is a price index or a performance index before comparing returns.

Next step

Next, you will start fundamental analysis by reading the income statement.