NASDAQ

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. Stocks traded on the NYSE are handled by a centralized DMM; each individual stock’s trades are handled by one DMM.

NASDAQ is an over-the-counter market (no physical trading floor) made up of dozens of market makers trading with the public. The market makers displaying the best prices typically attract the most business. If you recall from the common stock chapter, an OTC trade is one that does not take place at 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 stocks listed on its platform.

Market makers must be willing to provide a continuous quote on the securities they trade. There are legitimate reasons for temporary or permanent withdrawal (e.g., closing the business, sick employees, unforeseen events, etc.). In normal conditions, market makers provide consistent, ongoing quotes that look like this:

This quote works the same way as the other bid and ask quotes we’ve discussed in this chapter:

• The market maker is willing to buy up to 700 shares at $50.25.
• The market maker is willing to sell 300 shares at $50.50.
• The spread is $0.25 ($50.50 − $50.25).

NASDAQ includes dozens of market makers displaying quotes like this. Here’s what it looks like when all market maker quotes are aggregated:

*MPD = Market maker ID

First, test your knowledge: what’s the inside market?

On NASDAQ, the inside market is shown as a level 1 quote. When investors initially pull up a quote on a NASDAQ security, they see a level 1 quote displaying the best prices available in the market.

The visual above showing several market maker quotes is a level 2 quote, which provides a view beyond the best prices in the market. Investors can access NASDAQ’s level 2 quote system through their broker-dealers by special request. A level 2 quote can sometimes provide insight into market interest. For example, if there’s a large request to buy just below the highest bid, or a large request to sell just above the lowest ask, it can influence the general direction of the market.

A level 3 quote looks like a level 2 quote, but it’s interactive. Participating market makers are the only ones with access to level 3 quotes. They use this system to place new quotes, adjust current quotes, or remove old 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, which is the same as the NYSE. However, NASDAQ also offers pre-market and post-market hours, allowing investors to trade outside normal hours.

NASDAQ after-hours

• Pre-market: 4:00am - 9:30am ET
• Post-market: 4:00pm - 8:00pm ET

While pre- and post-market trading increases trading opportunities, it also adds risk. Fewer investors trade during these sessions, which can increase volatility. Most broker-dealers require customers to read a risk disclosure before trading in the pre- and post-markets. Investors should be aware of the larger spreads, lower trading volume, and higher volatility that can occur in these markets.

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, 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.