Stock Exchanges Flashcards
Who are the market makers?
An entity who makes the market by posting two-way quotes (bid and offer price) at which he is willing to buy or sell a security.
- They bear the risk of clearing all quantities under all market conditions
What is a Quote-driven market?
A market whereby securities are traded via designated market makers.
What is a Limit order book?
A centralised location (electronic rather than physical) where investors submit orders and stating the desired prices they wish trade.
What is an Order-driven market?
A market whereby securities are traded via the Limit order book only.
What are the 2 priority rules?
1) Price priority: Best price executes first
2) Time priority: First come first serve
What are Market Orders?
6
1) Immediate execution at best price
2) Trader do not specify price (price-taker)
3) Certainty with respect to execution but not price
4) Consumes liquidity
5) Most market orders are pure and plain market orders
6) Different exchanges offer different other types of market orders, which are not commonly not used
What are Limit Orders?
8
1) Trader specify the price to trade (limit price)
- Wait until the price is matched
2) Certainty with respect to price but not execution
3) The limit price for a limit buy (sell) order can be greater than, equal to, or less than the bid (offer) price
4) The higher (lower) the limit price for a limit buy (sell) order, the higher is the probability of execution
5) If the limit price of a limit buy (sell) order is higher (lower) then or equal to the offer (bid) price, it is called a marketable limit order, which functions like a market order.
6) In a pure order-driven market, limit orders are the sole suppliers of liquidity (“make the market”)
7) Most limit orders are pure and plain limit orders
8) Different exchanges offer different other types of limit orders, which are not commonly used.
- Assumed to be a day order unless stated otherwise
- Price priority > Time priority
What is NYSE?
New York Stock Exchange.
- Originally a quote-driven market
Who are the market makers of NYSE?
Specialists.
What do these Specialists do and where do they come from?
7
1) Members of NYSE
2) Dealers who specialises in certain stocks
3) Used to be the only ones who can access the limit order book
- They have a lot of information (information monopoly) –> Can strategise
4) Maintain the market: Continuous quotes throughout the day
5) Executing orders: By crossing, matching, or through own inventory
6) Balance the buy and sell pressure and stabilize prices by trading against the market trends
7) Every stock only has 1 specialist (Everyone that buys/sells have to buy/sell from a specialist)
- 1 specialist can handle more than 1 stock
How does technology affect market makers (Specialists)?
3
1) Market makers lose their edge of having more information
- With the internet, information is prevalent to even the general public
2) Companies begin selling information
3) Number of specialists has been falling (only left a few who do not do much) as the information monopoly is dwindling
What is Nasdaq?
4
National Association of Securities Dealers Automated Quotations.
1) A stock market that started out as a quote-driven OTC market
2) First electronic stock market
3) Claimed to list more companies and trade more shares per day than any other exchanges
> More companies –> More market makers per stock –> More competition to make the market
4) IT sector is the biggest and the most well-known sector in Nasdaq
What are ECN?
8
Electronic Communication Networks.
1) Early financial disruptors
2) Alternate trading system (ATS)
3) Electronic limit order book
4) Self-regulatory organisation (SRO): Minimal regulatory burdens vs NYSE where 1/3 of NYSE employees are regulatory units
5) Pseudo-exchange
6) Very fast execution at very low transaction costs
7) Very fast market acceptance
8) No human intervention
Increase competitiveness, exchanges found it hard to survive.
Therefore, these exchanges bought ECN. (Nasdaq bought Instinet)
Examples of ECN?
4
1) Archipelago
2) Instinet
3) Island
4) NexTrade
*Many are now exchanges and playing a major role in the security trading industry
What are Online Brokers?
4
1) New disruptors
2) Zero commission and trading fee
3) Make profit by:
> Payment for order flow (PFOF) –> With designated market makers, online brokers have to pass the order to the market makers to make the trade and profit from the transaction
> Direct orders to market makers (e.g. Citadel)
> Selling data
4) Made possible due to technological advances and information through social media –> Market environment changed very differently
*Pandemic: Retail portion of trades increased from 10% to 25%
