Securities Quoting
Understanding how securities are quoted and priced is fundamental to trading. This section covers bid-ask spreads, market maker roles, and the differences between auction and dealer markets.
Bid and Ask Prices
Every quoted security has two prices:
The Bid Price
- The price at which a market maker will buy from you
- The price you receive when selling
- Always the lower of the two prices
The Ask (Offer) Price
- The price at which a market maker will sell to you
- The price you pay when buying
- Always the higher of the two prices
Memory Tip: "Bid means buy" - the market maker is bidding to buy from customers at this price.
Quote Example
| Price | |
|---|---|
| Bid | $49.95 |
| Ask | $50.05 |
| Spread | $0.10 |
If you want to:
- Buy: You pay the ask ($50.05)
- Sell: You receive the bid ($49.95)
The Bid-Ask Spread
The spread is the difference between the ask and bid prices.
Spread = Ask - Bid
| Bid | Ask | Spread |
|---|---|---|
| $49.95 | $50.05 | $0.10 |
| $25.00 | $25.50 | $0.50 |
| $100.00 | $100.02 | $0.02 |
What Affects Spread Width?
| Factor | Narrow Spread | Wide Spread |
|---|---|---|
| Liquidity | High volume trading | Low volume trading |
| Volatility | Stable prices | Volatile prices |
| Competition | Many market makers | Few market makers |
| Stock Price | Often narrower in % terms | Can be wider |
Key Point: A tight (narrow) spread indicates high liquidity and an efficient market. A wide spread indicates lower liquidity and higher trading costs.
Market Makers
Market makers are dealers who stand ready to buy and sell securities, providing liquidity to the market.
Market Maker Obligations
- Display bid and ask quotes during market hours
- Trade at their quoted prices
- Maintain orderly markets
- Provide two-sided quotes (both bid and ask)
How Market Makers Profit
Market makers earn money through the spread:
- Buy from customer at bid ($49.95)
- Sell to another customer at ask ($50.05)
- Profit = $0.10 per share
Note: With high volume, even small spreads generate substantial profits.
Auction Market vs. Dealer Market
Securities trade in two main types of markets:
Auction Market (NYSE)
| Feature | Description |
|---|---|
| Structure | Centralized exchange with single location |
| Price Discovery | Buyers and sellers compete openly |
| Key Player | Designated Market Maker (DMM) |
| Matching | Orders matched directly when possible |
| Quote Source | Consolidated from all orders |
The NYSE is an auction market where:
- Buyers compete to buy at the lowest price
- Sellers compete to sell at the highest price
- The DMM facilitates trading and maintains order
Dealer Market (Nasdaq)
| Feature | Description |
|---|---|
| Structure | Decentralized, electronic network |
| Price Discovery | Multiple dealers compete for business |
| Key Player | Multiple competing market makers |
| Matching | Trades through dealers |
| Quote Source | Each market maker posts quotes |
Nasdaq is a dealer (negotiated) market where:
- Multiple market makers compete
- Each posts their own bid-ask quotes
- Best prices displayed through the system
Comparison
| Auction (NYSE) | Dealer (Nasdaq) | |
|---|---|---|
| Location | Physical exchange | Electronic network |
| Market Makers | One DMM per stock | Multiple per stock |
| Competition | Buyers vs. sellers | Dealers vs. dealers |
| Example | New York Stock Exchange | Nasdaq Stock Market |
Inside Market (NBBO)
The National Best Bid and Offer (NBBO) represents the best available prices across all market centers.
Inside Market Defined
| Term | Meaning |
|---|---|
| Inside Bid | Highest bid price available |
| Inside Ask | Lowest ask price available |
| Inside Spread | Difference between inside bid and ask |
Example: Multiple Market Makers
| Market Maker | Bid | Ask |
|---|---|---|
| MM1 | $50.00 | $50.08 |
| MM2 | $50.02 | $50.06 |
| MM3 | $49.98 | $50.10 |
NBBO:
- Inside Bid: $50.02 (highest)
- Inside Ask: $50.06 (lowest)
- Inside Spread: $0.04
Best Execution: Brokers must seek the best available prices for customer orders, generally at or better than the NBBO.
Quote Size
Quotes also include the number of shares available at each price:
Reading a Quote with Size
Quote: 50.02 x 50.06 (5 x 3)
| Component | Meaning |
|---|---|
| 50.02 | Bid price |
| 50.06 | Ask price |
| 5 | 500 shares available at bid |
| 3 | 300 shares available at ask |
Note: Size is typically shown in round lots (multiply by 100).
Firm vs. Subject Quotes
| Quote Type | Meaning |
|---|---|
| Firm Quote | Market maker must honor the price and size |
| Subject Quote | Indicates interest but not binding |
| Nominal Quote | For information only, not tradeable |
Regulation: Market makers must generally honor their firm quotes. Backing away from a firm quote is a violation.
Key Takeaways
- Bid = dealer buys / you sell (lower price)
- Ask = dealer sells / you buy (higher price)
- Spread = dealer's profit margin
- Narrow spreads indicate liquid, efficient markets
- NYSE is an auction market; Nasdaq is a dealer market
- NBBO shows the best available prices
- Market makers must honor firm quotes
A stock is quoted at $45.50 bid, $45.75 ask. If a customer wants to buy 100 shares, what price will they pay?
A narrow bid-ask spread typically indicates:
What type of market is Nasdaq considered?
3.4 Account Types
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