Quick Answer
Two market models split everything: the New York Stock Exchange auction runs one Designated Market Maker per stock, while Nasdaq and over-the-counter markets use multiple competing dealers. Firm quotes are binding; backing away is a violation. Circuit breakers pause the whole market at 7%, 13%, and 20%; Limit Up-Limit Down pauses a single security. Customers always get the worse side of the spread.
The whole unit on one sheet: who makes markets, which quotes bind, what stops trading, and which reporting system catches each trade.
Market Structure Core
- Primary market = new issues; secondary market = investors trading with each other. Market makers live in the secondary market.
- The four markets: First (on an exchange), Second (over-the-counter, OTC, of unlisted securities), Third (OTC of exchange-listed securities), Fourth (institution-to-institution via Electronic Communications Networks, ECNs).
- Auction market (NYSE): competitive bidding, one Designated Market Maker (DMM) per security. Dealer market (Nasdaq, OTC): competing dealers quote. Nasdaq is a dealer market even though it is an exchange.
Market Makers: DMM vs. OTC
| Feature | NYSE DMM | Nasdaq / OTC Market Makers |
|---|---|---|
| Number per security | One | Multiple competing |
| Capacity | Agent and principal (never same trade) | Principal only (dealers) |
| Price discovery | Auction | Competing dealer quotes |
- Affirmative obligation: the DMM must step in and trade against the trend when public liquidity is insufficient.
- Negative obligation: the DMM must step back when public orders are sufficient.
- OTC Markets tiers: OTCQX (highest disclosure, lowest risk), OTCQB (venture), OTC Pink (lowest disclosure, penny stocks and shells). Penny stocks cannot qualify for OTCQX.
Types of Quotations
| Quote | Binding? | Used When |
|---|---|---|
| Firm | Yes; must execute at price and size | Default for inter-dealer systems |
| Subject | No; can change before executing | Wants flexibility |
| Workout | No; a price range, needs time | Illiquid securities |
| Nominal | No; informational only (must be labeled) | No active interest |
| Bid Wanted / Offer Wanted | No; soliciting interest | Municipal, thinly traded |
The One-Liners That Win Points
- Customer sells at the bid, buys at the ask: always the worse side.
- National Best Bid and Offer (NBBO) = highest bid, lowest ask across all market centers; Regulation National Market System (Reg NMS) routes orders there and prevents trade-throughs.
- Backing away (refusing to honor a firm quote) is a violation inconsistent with just and equitable principles of trade.
- During a trading halt everything stops: no trades, no quotes, no bid/offer-wanted indications.
- Order tickets need two time stamps: receipt AND execution. Short-sale indicator is required.
- Best execution applies to all customer orders; payment for order flow (PFOF) never excuses a worse price.
Numbers to Lock In
| Item | Value |
|---|---|
| Market-wide circuit breakers | 7% (Level 1), 13% (Level 2), 20% (Level 3) |
| Level 1 / Level 2 halt duration | 15 minutes, only before 3:25 PM Eastern Time |
| Level 3 (20%) | Halts trading rest of day, any time |
| LULD limit state to pause | 15 seconds unresolved, then 5-minute pause |
| LULD reference price | Rolling 5-minute average |
| TRACE / EMMA reporting deadline | Within 15 minutes of execution |
| Penny stock threshold | Under $5 per share |
| NYSE block trade | 10,000+ shares or $200,000+ market value |
Transaction Reporting: Which System?
| System | Covers | Operator |
|---|---|---|
| TRACE | Corporate bonds, agency debt, asset-backed securities | FINRA |
| EMMA / RTRS | Municipal securities | MSRB |
| TRF (Trade Reporting Facility) | Listed stocks traded OTC (third market) | FINRA |
| ORF (OTC Reporting Facility) | Unlisted OTC equities | FINRA |
- Consolidated tape: Tape A (NYSE), Tape B (regional), Tape C (Nasdaq).
Top Gotchas
- Circuit breakers vs. LULD: market-wide circuit breakers halt everything on an S&P 500 drop; Limit Up-Limit Down (LULD) pauses a single National Market System security outside its price band.
- 3:25 PM cutoff: a 7% or 13% decline after 3:25 PM does NOT halt trading; only Level 3 (20%) can halt at any time.
- TRACE is not municipals: corporate bonds go through TRACE, munis go through EMMA; both report within 15 minutes.
- A DMM cannot be agent and principal in the same trade; principal trades require confirmation disclosure.
- Open-order adjustment on the ex-date: buy limits, sell stops, and stop-limits below the market are reduced by the dividend; sell limits are NOT. "Do not reduce" (DNR) orders are never adjusted.
- Interpositioning is a violation only when the added middleman produces a worse price; the burden of proof is on the firm.
- Penny stock disclosures (inside bid/ask, quantity, and total compensation, all before the trade) apply to OTC penny stocks only, not to a sub-$5 stock listed on Nasdaq or an exchange.
- Block trades may execute outside the NBBO; ordinary cross transactions must be at or between the NBBO.
One-Breath Recap
The NYSE auction runs one Designated Market Maker per stock with paired affirmative and negative obligations, while Nasdaq and over-the-counter markets use competing dealers, and only firm quotes bind. Customers take the worse side of the spread, Reg NMS routes to the NBBO, circuit breakers stop the whole market at 7%, 13%, and 20% while Limit Up-Limit Down pauses one security, and each trade reports to its own system: TRACE for corporates, EMMA for munis, TRF and ORF for stocks.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Market Making and Quotations unit for the complete lesson.