Securities that are not listed on any of the centralized exchanges trade over the counter or on the NASDAQ. NASDAQ stands for National Association of Securities Dealers Automated Quotation System. It is the inter-dealer network of computers and phone lines that allows securities to be traded between broker dealers. NASDAQ is not an auction market it is a negotiated market, and has been granted exchange status by the SEC. One broker dealer negotiates a price directly with another broker dealer. None of the other interested parties for that particular security have any idea of what terms are being proposed. The broker dealers may communicate over their NASDAQ workstations or can speak directly to one another over the phone. The normal business hours for the NASDAQ market are from 9:30 AM to 4:00 PM EST.
Because there are no specialists for the over the counter markets, bids and offers are displayed by broker dealers known as market makers. A market maker is a firm that is required to display a two-sided market. A two-sided market consists of a simultaneous bid and offer for the security quoted through the NASDAQ workstation. The market maker must be willing to buy the security and the bid price, which they have displayed, as well as be willing to sell the security at the offering price, which they have displayed. These are known as firm quotes. There is no centralized location for the NASDAQ market; it is simply a network of computers, which connects broker dealers throughout the world. Market makers purchase the security at the bid price and sell the security at the offering price. Their profit is the difference between the bid and the offer known as the "spread". Rule changes and new trading systems known as ECN's or electronic communication networks have narrowed the spreads on stocks significantly in recent years. Firms that act as market makers must continuously display two-sided quotes during normal business hours.
Broker dealers will subscribe to the NASDAQ workstation services that meet their firm's requirements. The levels of service are:
Level I: NASDAQ Level I subscription service provides information relating to the inside market, last sale, and daily volume data and provides quotes for registered representatives.
Level II: NASDAQ Level II allows the subscriber to see the inside market, the quotes of all market makers, the total daily volume, and the high and low for the day.
Level III: NASDAQ Level III is the highest level of service offered over the NASDAQ workstation. Level III contains all of the features of Level II and allows the firm to enter and update their own markets. Level III is only for approved market makers.
All broker dealers who wish to register as a marker maker must file an application with FINRA and demonstrate that they are in good standing with the Association and that the firm meets the capital requirements to become a market maker. The broker dealer's registration will become effective upon notification by FINRA. Once approved, a broker dealer must register in each security it wishes to make a market in, prior to quoting that security. Broker dealers may not receive any consideration from the issuer or from promoters for making a market in the security. As a result of recent SEC order handling rules all market makers will be considered primary market makers and will be exempt from the NASDAQ short sale rule.
Most actively traded NASDAQ stocks are quoted by a large number of market makers. As market makers enter their quotes, some will be above or below the best quote known as the inside market. A market maker whose quote is above or below the inside market is said to be away from the market. As the market makers adjust their quotes, the market maker who is publishing the highest bid for the security has their bid displayed at the top of the list and their bid is published as the best bid to anyone with a NASDAQ Level I subscription service or higher. The market maker publishing the lowest offer will have their offer listed at the top of the list and published as the lowest offer to anyone with a NASDAQ Level I subscription service or higher. As a result, the best bid and offer from any two market makers will make up the inside market.
Notice how the inside market for XYAD consists of the bid from market maker 2 and the offer from market maker 3. All of the other market makers are away from the market.
Market makers may not enter quotes that would lock or cross the market. A locked market is one where the bid and offer are equal in price. For example, if another market maker came into the above listed market for XYAD known as market maker 6, and entered a bid of 15.05 or an offer of 15.00, the bid or offer entered would lock the market. A crossed market is one where a bid is entered that is higher than the offer or, one where an offer is entered that is lower than the bid. If market maker 6 entered a bid of 15.10 or an offer of 14.95 the bid or offer would cross the market. A market maker who has an order that would cause them to enter a bid or offer that would lock or cross the marker must make an effort to trade with all the market makers whose bid or offer they would lock or cross. The NASDAQ system helps alleviate most locked or crossed markets.
All quotes published over the NASDAQ workstation are firm quotes. A dealer who fails to honor their quotes has committed a violation known as backing away. Dealers who provide quotes over the phone, which are clearly indicated as being subject or nominal, cannot be held to trade at those prices. NASDAQ qualifiers are:
A response of "it is" would indicate a firm quote. A firm quote is always good for at least one round lot or 100 shares.
Most NASDAQ trades are executed over the NASDAQ workstation using one of its automated execution systems. These systems allow dealers to execute orders without having to speak with one another on the phone.
The NASDAQ Market Center Execution System accepts market orders and immediately executable limit orders for both customer and firm accounts. Orders may be entered for up to 999,999 shares per order. The orders will immediately be routed to dealers on the inside market for automatic execution. Larger orders may be split up to meet the maximum order volume. Orders executed through the NASDAQ Market Center Execution System are automatically reported to act. Orders executed through the NASDAQ Market Center Execution System are executed based on the priority of price and time. Orders will be executed against the market maker that is quoting the best price first. If more than one market maker is quoting the same price, orders will be executed against the market maker who quoted the best price first. Orders may be entered in the NASDAQ Market Center Execution System by both market makers and order entry firms. Firms may modify the way that their orders are routed to market makers by selecting: