Originally started in the 1970s as an association of dealers, NASDAQ grew into one of the largest exchanges in the world. Unlike the NYSE, which operates as an auction market, NASDAQ is considered a negotiated market. On the NYSE, trading in each listed stock is facilitated by a centralized Designated Market Maker (DMM); each stock’s trades are handled by one DMM.
NASDAQ is an over-the-counter market (there’s no physical trading floor) made up of dozens of market makers who trade with the public. Market makers compete with one another, and the firms showing the best prices tend to attract the most orders. An OTC trade is a trade that does not take place on a physical exchange. Even so, NASDAQ is still considered to have “exchange status,” and its stocks are treated as exchange-listed. Like the NYSE, NASDAQ has high standards for companies that want to list.
Market makers must be willing to provide continuous quotes on the securities they trade. There are legitimate reasons for a temporary or permanent withdrawal (e.g., closing the business, sick employees, unforeseen events, etc.). In practice, market makers typically provide consistent, ongoing quotes that look like this:
| Bid | Ask | |
|---|---|---|
| Price | $50.25 | $50.50 |
| Size | 7 | 3 |
This quote works the same way as the bid and ask quotes we’ve used throughout this chapter:
NASDAQ includes dozens of market makers displaying quotes like this. When you combine (aggregate) all of their quotes, you get a market-wide view like the one below:
*MPD = Market maker ID
First, let’s check your understanding: what’s the inside market?
Answer = $50.30 x $50.45 / 1 x 2
The inside market is the price and number of shares available at the highest bid (buy order) and the lowest ask (sell order).
On NASDAQ, the inside market is shown in a level 1 quote. When investors first pull up a quote on a NASDAQ security, they typically see a level 1 quote showing the best prices currently available.
The visual above showing multiple market maker quotes is a level 2 quote. A level 2 quote goes beyond the inside market by displaying additional quotes from market makers. Investors can usually access NASDAQ’s level 2 quote system through their broker-dealers by special request. Level 2 data can sometimes provide insight into supply and demand. For example, a large interest to buy just below the highest bid, or to sell just above the lowest ask, can influence the market’s direction.
A level 3 quote looks like a level 2 quote, but it’s interactive. Only participating market makers have access to level 3 quotes. They use this system to enter new quotes, adjust existing quotes, or remove quotes.
NASDAQ uses its own execution system for routing trades, known as the NASDAQ Market Center Execution System. Market makers using this system can enter quotes for up to 999,999 shares (just short of 1 million).
NASDAQ is open daily from 9:30am-4:00pm ET for normal operating hours, the same as the NYSE. NASDAQ also offers pre-market and post-market trading, which allows investors to trade outside normal hours.
NASDAQ after-hours
Pre-market and post-market trading can increase trading opportunities, but they also add risk. Fewer investors trade during these sessions, which can increase volatility. Most broker-dealers require customers to review a risk disclosure before trading in pre- and post-market sessions. Key risks include wider spreads, lower trading volume, and higher volatility.
The NYSE and NASDAQ used to regulate their own markets as self-regulatory organizations (SROs). SROs are granted regulatory power and oversee the participants in their markets. In 2007, the NYSE’s and NASDAQ’s regulatory arms combined into FINRA, which is the SRO that now supervises both markets. Although FINRA is not a governmental entity, it has the power to control who operates in the financial markets and how financial firms interact with the investing public.
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