The New York Stock Exchange

Functioning in some form since 1792, the New York Stock Exchange (NYSE) is the world’s largest stock exchange. The NYSE operates as an auction market, where a designated market maker (DMM) facilitates all trading for a stock. Similar to how any other auction works, the DMM (auctioneer) matches buyers with sellers, but also trades with the public out of their inventory. In any given trade, they can operate in an agency or principal transaction.

In reality, the DMM is both a person working on the floor of the NYSE and a glorified computer system. The speed of the financial markets in today’s digital age makes it impossible for any human to manually execute all trades as a market maker. Most market makers in the financial markets are run by complex digital programs and algorithms that react nearly instantaneously to changes in the market. However, there still are people behind the scenes that ensure trading systems work properly and step in to manually trade if needed. Private companies are hired by the NYSE to operate as DMMs, who then send a select employee to operate the DMM post. If you’re really interested, here’s a link to a NYSE-created YouTube video describing the role of DMMs.

There are several DMMs on the NYSE, but each listed stock is handled by one DMM. For example, all trades of Coca-Cola stock (listed on the NYSE) are facilitated by one specific DMM. The primary goal of the DMM is to “maintain fair and orderly markets” and minimize any potential liquidity problems. In plain English, their job is to make sure investors can trade at accurate market prices at any time (during normal business hours).

There are several ways the NYSE accomplishes this task. First, there’s a complex routing system traditionally referred to as the Super Display Book. When financial firms submit customer orders to the NYSE, most orders go through this system, which directs the order to the DMM for execution. In 2012, the Super Display Book system was updated to the modern Universal Trading Platform, but FINRA still refers to the Super Display Book as the NYSE’s system to this day.

If it’s a limit order currently “away from the market,” the DMM will place the order on their “book,” known as the DMM’s book. To better understand this, let’s look at a basic example of what the DMM’s book could look like:

When a DMM looks at market dynamics, they’ll pull up a screen looking something like this. For the most part, it’s a complex bid & ask system. The left side represents all buy limit orders placed by financial firms on behalf of their customers (the IDs represent the firms submitting the order; you don’t need to know IDs for specific firms), while the right side represents all sell limit orders. All of these orders are currently “away from the market,” meaning they cannot be filled with the current market price. The last completed trade was for 500 shares at $40.25, which is in between the highest bid and lowest ask.

The best buy order is for 100 shares at $40.00, while the best sell order is for 300 shares at $40.50. This is the inside market, which represents the best available prices currently on the DMM’s book. Therefore, the inside market is:

40.00 x 40.50

1 x 3

Market orders are often matched against the limit orders on the book. Click the link above for a full review of market orders, but these are orders requesting a trade at the next available price. If a market order to buy 300 shares came into the system, it could be matched against the trade placed on the book at $40.50. In this instance, the DMM acts in an agency capacity by matching a buyer (the market order to buy) with a seller (the $40.50 limit to sell).

If the DMM felt the $0.50 cent spread (between the highest bid and lowest ask) was too much, they could step in and fulfill the market order at a better price than $40.50. Let’s assume the DMM sells 300 shares from their inventory at $40.40, which is a $0.10 per share price improvement over the limit order to sell 300 shares at $40.50. This is how DMMs primarily operate in principal capacities. Instead of matching market orders against their book, they step in and buy shares into or sell shares from their inventory. The only requirement they must follow is to avoid competing with public orders. For this example, this means they cannot sell shares from inventory for $40.50 or higher or buy shares into their inventory for $40.00 or lower. If they did, they would be trading in front of the public orders on their book.

The last few paragraphs detail how the DMM carries out its goal of maintaining a fair, orderly, and liquid market. If enough investors are trading in the market, they’ll step aside and match buyers and sellers (agency). If there’s a lack of trading or a large spread, they’ll step in and trade directly with public customers (principal).

Here’s a video that dives further into DMM’s role with bid and ask spreads and how to approach test questions on the topic:

DMMs are also authorized to stop stock, which freezes the price of a security for a short amount of time. This is most often done for floor brokers, which also roam the floor of the NYSE. Floor brokers work on behalf of financial firms that send trades to the NYSE.

For example, Charles Schwab could send a representative to the floor of the NYSE to facilitate large trades for its customers (small trades are routinely handled by the system with no human input). If Charles Schwab received a large order for an NYSE-listed stock from a customer, the trade could be sent to the floor broker. From there, the floor broker would talk with the DMM and other floor brokers to find the best possible price for the customer. If the DMM felt inclined to do so, they could quote a price to the floor broker and “lock it in” (stop the stock) for a short amount of time. For that short period of time, the floor broker will attempt to find a better price among other brokers. If a better price isn’t found by the end of the time period, they’ll go back to the DMM and take them up on their offer. DMMs can only stop stock for public orders; they cannot do it for themselves or for a financial firm’s trading account.

The NYSE only trades stocks that are “listed” on the exchange. To be listed, issuers must meet certain characteristics, like market capitalization and minimum numbers of shareholders. You don’t need to know these listing requirements, but you should be aware that only the largest companies with the most actively traded stocks are traded on the NYSE.

As we’ve discussed throughout this section, one of the NYSE’s goals is to maintain fair and orderly markets. After Black Monday occurred back in 1987, the NYSE instituted circuit breakers in the markets to prevent a market “death spiral.” Sometimes referred to as trading curbs, circuit breakers shut the market down for short periods of time when there’s a large and quick market decline. The S&P 500 represents “the market” for circuit breaker purposes. Here are the rules, which are enforced on a daily basis:

7% decline before 3:25pm ET

• 15-minute trading halt

13% decline before 3:25pm ET

• 15-minute trading halt

20% decline at any time

• Market shuts down for the day

Circuit breakers don’t completely fix the problem, but it stops the downward momentum temporarily. While the NYSE created the system, all of the large exchanges enforce the rule today. Circuit breakers don’t commonly occur, but they were enforced during the 2010 Flash Crash (when the market fell by 9% in just minutes) and four separate times during the COVID-19 market volatility in March 2020.

The NYSE is open every business day from 9:30am to 4:00pm ET. DMMs commonly come to work early (usually around 7am ET) to analyze market data for something known as price discovery. When the market is closed, trades still are submitted into the system by financial firms. If there’s an abundance of purchase orders placed overnight, the DMM will start trading the stock at a higher price than its closing price the night before (and vice versa). Determining the opening price based on pre-market demand is referred to as price discovery.

The NYSE isn’t the only exchange that works the way it does. In fact, there are a few other exchanges that are modeled after the NYSE’s structure. There’s the American Stock Exchange, referred to as NYSE-MKT, which is also a large national exchange. Additionally, there are regional exchanges that are similar to the NYSE, like the Philadelphia Stock Exchange. It’s possible that a stock may trade on the NYSE and another exchange, typically a regional one. These are referred to as dual-listed stocks.

As we learned earlier in the common stock chapter, there are different segmentations to the market. Any trade that takes place on the NYSE is considered a first market trade. As a reminder, a first market trade is a trade of a listed stock on an exchange. In the same section, we also discussed the existence of the third market. As a reminder, the third market is where listed securities (like those traded on the NYSE) trade outside of their primary markets in the OTC markets.

It could become difficult for investors to find the best price if the same security trades in multiple markets. Thankfully, the Consolidated Quotation System (CQS) mitigates that problem. The CQS provides a resource called the consolidated tape, which reports quotes across multiple markets for securities listed on exchanges like the NYSE and NASDAQ. If an investor wants a “full view” of quotes for an NYSE-listed security, the CQS is a great resource. The consolidated tape combines first and third market quotes, but does not include the second market (the non-NASDAQ OTC markets).