What Is a Dealer Market?
Let me explain what a dealer market is. It's a financial market where multiple dealers post prices for buying and selling specific securities, ensuring liquidity and transparency. As a market maker, a dealer electronically displays the bid price for buying and the offer price for selling a security. You'll see this in action with bonds and foreign exchanges, and Nasdaq serves as a key example for equity trading.
Key Takeaways
Understand that a dealer market is a transparent setup where dealers post their buy and sell prices for securities. Bonds and foreign exchanges mainly operate this way, and some stock exchanges like Nasdaq function as dealer markets for equities. Importantly, dealers use their own capital to provide liquidity, cutting out brokers from the process. You can contrast this with auction markets and brokered markets.
How Dealer Markets Work
In a dealer market, a market maker commits their own capital to offer liquidity to you as an investor. Their main way to control risk is through the bid-ask spread, which costs you but profits them. This setup differs from an auction market, where a single specialist in one location, like the NYSE trading floor, matches buyers and sellers for a security.
Dealer Markets vs. Broker Markets
Know that in a broker market, a trade needs a specific buyer and seller. In a dealer market, you execute buys and sells independently through dealers acting as market makers. Brokers handle trades for others, while dealers trade on their own behalf. Brokers deal in securities for clients, but dealers manage their own accounts. Brokers lack the freedom to buy or sell freely, unlike dealers who have full rights. Brokers earn commissions, but dealers, as principals, do not.
Example of a Dealer Market
Consider Dealer A with a large inventory of WiseWidget Co. stock on Nasdaq, where the national best bid and offer is $10 / $10.05. If Dealer A wants to sell some, they might post $9.95 / $10.03, lowering it to attract buyers. You, as a buyer, would take the $10.03 offer since it's cheaper than $10.05 elsewhere. Sellers, however, wouldn't hit the $9.95 bid, as it's lower than the $10 from other dealers.
What Is the Difference Between a Trader and a Dealer?
A dealer is a type of trader who always provides two-sided markets in their securities, posting both bids and offers to profit from the bid-ask spread through frequent trades. Traders don't have to do this; they buy or sell as they wish and act as price takers, hoping for market moves to profit later.
What Are the Types of Securities Dealers?
Broker-dealers are regulated entities trading securities for themselves and clients. Some act purely as agents, facilitating client trades for commissions. Others act as both principal and agent, trading from their accounts. They fall into wirehouses selling their own products or independent ones offering external products.
Is Robinhood a Dealer Market?
No, Robinhood is a broker, not a dealer market. It's registered as a broker-dealer with FINRA, executing trades only for customers without taking the other side or forming its own marketplace.
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