Exchange, OTC, Third Market

Where stocks trade - Exchange, OTC, Third Market

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As mentioned a little earlier, one of the benefits of owning common stock is liquidity and that liquidity comes from a very active marketplace.

In the United States, the securities markets are first separated into two major market categories: primary and secondary.

The Primary Market is when a company sells their shares to the public for the first time in an Initial Public Offering (IP0). The company itself receives the proceeds from an IP0.

The Secondary Market, on the other hand, is where trades are made between investors who are now the ones to get the proceeds, not the companies who originally issued the shares in IPOs.

The Secondary Market is broken down into four component markets, only three of which will be of immediate interest to investors.

The Exchange or "Auction" Market
This market includes the New York Stock Exchange and the American Stock Exchange as well as the various "regional" exchanges such as the Philadelphia Stock Exchange and the Pacific Exchange. Stocks trading on any of these exchanges are said to be "listed" on those exchanges. That means they meet the various requirements imposed by the exchanges. At the same time, there is in the word "listed" an homage to times past when the names of stocks actually were written down by hand on large wallboards for all brokers to see. To this day, for example, the NYSE is still called "The Big Board."

The Over-the-Counter Market (OTC)
Unlike the exchanges which all occupy actual bricks-and-mortar physical addresses, the OTC market is an association of broker/dealers connected by computer and telephone networks who trade "unlisted" securities. Further, the OTC Market is usually broken down into three component markets including National Market Stocks, those being the best known and financially stable OTC companies; Small Capitalization Stocks, meaning riskier emerging growth companies; and finally, the speculative "Pink Sheet" or "Bulletin Board" stocks. The OTC market is regulated by both the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Unlike the auctions on the exchanges, OTC trades are negotiated. Most OTC broker/dealers follow price changes on the FINRA's automated quotation system which has become well-known to many investors by its acronym, "Nasdaq".

The Third Market
Here nonexchange member broker/dealers and institutional investors trade over the counter in exchange-listed securities. Any listed security can be traded in the Third Market. Each trade must be reported to the Consolidated Tape within 90 seconds. Third market trades closely reflect the trading activity of any given stock on its primary exchange.

orders for listed stocks are executed in the Third Market or on Regional Exchanges.


The Third Market in action

Many orders for listed stocks are sent to a broker/dealer in the Third Market for execution. The Third Market is part of the overall OTC market. Specifically, it is a telephone and computer network of broker/dealers who are registered with the FINRA to make markets in exchange-listed securities.

When your market buy order gets to the market, the market maker immediately "fills" it at the best price then available. We use the word "immediately" because that's when market orders are filled. The so-called "best price" is continuously tracked as it changes throughout the day by computers in every broker/dealer office.

Your limit triggers and short sale ticks

In the system, it is the price activity on the stock's primary exchange that always determines when the various limit orders can be executed as well as short sales, and it is the movement of the stock on the primary exchange that triggers the uptick rule for your short sale.


The OTC Market

The OTC market works a bit differently than the Third Market.

Since the OTC trades "not listed" securities there is no bookmarking because the stock isn't traded on an exchange.

In the system, investors are guaranteed a trade at the best bid and ask price available when the order reaches the OTC market maker. This price is known as the "inside price". It is also called the "National Best Bid and Offer" (NBBO) because it represents a composite of prices from broker/dealers throughout the country.

On Market orders, the NBBO is good for a minimum 100 shares. Above that, the greater the size of the order, the greater is your chance of being filled in partial executions at higher prices.

On limit orders, the NBBO is still good for a minimum of 100 shares but you're still risking partial executions. However, in this case, you do not have the additional concern of rising prices to contend with. Some investors place AON (all or none) restrictions on their order to avoid partial executions.

You can also enter limit orders and sell short in the OTC market just as you would for listed stocks.