NASDAQ

Originally formed 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 a negotiated market. Instead of a single centralized designated market maker (DMM) handling trades in a stock, NASDAQ relies on dozens of market makers who trade with the public. The market makers posting the best prices attract the most trading activity.

Market makers trade only in a principal capacity, meaning they buy and sell for their own accounts. A helpful analogy is a used car dealership:

• People sell used cars to the dealership at a marked down price.
• The dealer adds the car to its inventory.
• The dealer then tries to sell the car to the public at a marked up price.
• If the car sells, the dealer earns the spread (the difference between the purchase price and the sale price).

Now imagine dozens of dealerships competing for business. Replace the dealerships with market makers and the cars with stocks, and you have the basic idea of how NASDAQ operates.

NASDAQ is considered an over-the-counter (OTC) market because it doesn’t have a physical trading floor. As you saw in the common stock chapter, an OTC trade is one that does not take place on a physical exchange. However, NASDAQ still has “exchange status,” and its stocks are treated as exchange-listed. Like the NYSE, NASDAQ maintains high listing standards for companies that want their shares traded on its platform.

The NYSE and NASDAQ used to regulate their own markets as self-regulatory organizations (SROs). SROs are granted regulatory authority and oversee the participants in their markets. In 2007, the NYSE’s and NASDAQ’s regulatory arms combined into FINRA, the SRO that now supervises both markets. Although FINRA isn’t a government agency, it has the power to control who may operate in the financial markets and how financial firms interact with the investing public.