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) (sometimes referred to as the “specialist”) facilitates trading for a stock. Like any auction, the DMM (acting as the auctioneer) matches buyers with sellers. The DMM may also trade with the public out of their own inventory. In any given trade, the DMM may act in an agency or principal capacity.
Because the DMM can act as either an agent or a principal, regulators focus on whether public orders might lose priority to the DMM.
For example, suppose an investor places an order to buy 100 shares at $50, and the order is routed to the DMM. At the same time, the DMM receives an order from another investor to sell 100 shares at the current market price (a market order). Instead of crossing the two public orders on an agency basis, the DMM steps in front of the selling investor and sells shares from the DMM’s own inventory. This prohibited practice is called trading ahead.
Public customer orders must be given priority over principal trades placed by the DMM. However, there are a few exceptions to keep in mind:
The NYSE trades only stocks that are “listed” on the exchange. To be listed, issuers must meet certain characteristics, such as market capitalization and a minimum number of shareholders. You don’t need to memorize the listing requirements, but you should know the practical takeaway: the NYSE generally lists larger companies with more actively traded stocks.
In addition to the NYSE, many other exchanges operate in a similar way. For example, the American Stock Exchange, referred to as NYSE-MKT, is also a large national exchange. There are also regional exchanges, such as the Philadelphia Stock Exchange. A stock may trade on the NYSE and on another exchange (often a regional exchange). These are called 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, meaning a listed stock is traded directly on an exchange.
Here’s a video covering the DMM’s role in conjunction with bid and ask spreads:
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