What is the Dealer Market?
A dealer market is a place where dealers engage in buying and selling of a specific financial instrument electronically using their own account, without involving a third party and make the market by quoting the offer price (price at which they are ready to sell) and bid price (price at which they are ready to buy).
A dealer in this market is referred to as market makers since they offer the securities for buy or sell at the bid or offer price. The market provides greater liquidity to the investors. It is made up of many market makers who are connected through a telecommunication network; it doesn’t have a centralized trading floor. A dealer makes the market in securities by offering either buy or sell them at offer or bid price. It is also called over the counter (OTC) market.
Example of Dealer Market
Bonds and foreign exchanges are primarily traded in over the counter (OTC) market. NASDAQ (National Association of Securities and Dealer Automated Quotation System) is a prominent dealer market which deals in equity stocks as well. NASDAQ system founded in 1971 as a part of the Over The Counter (OTC) market, now it is considered as a separate entity. In this market, a buyer and seller are never put together, instead, their orders are (buy/sell) executed through marker makers that are the dealers.
Dealer Market vs Auction Market
An auction market is a trading platform where buyers and sellers come together and enter into bids and offers, and the transaction happens only when both the buyers and sellers agree on a price.
|Dealer Market||Auction Market|
|A financial market where a dealer engages in buying and selling of securities using their own account.||A market where the buyers and sellers enter competitive bids and offers, respectively, at the same time.|
|The dealer is considered as market maker and quotes the bid and offer prices of the securities and makes the market in security and investors who accept the prices can do the transaction electronically.||In an auction market, the potential buyers and sellers meet in a common platform, where they enter the competitive offer and bid prices and the trade executed only when the matching bid and offer come together.|
|It is quote driven.||An auction market is order-driven.|
|There is no centralized trading floor for this market.||An auction market has a centralized trading floor.|
|NASDAQ ((National Association of Securities and Dealer Automated Quotation) system is a dealer market.||NYSE (New York Stock Exchange) is an example of the auction market.|
|There are multiple dealers in this market.||There is a single specialist in an auction market, in a centralized location who controls the liquidity and trading activity by pairing the matching bids and offers.|
|In this market, the dealer holds the stock of securities and quote the offer and bid price, electronically. The buyers and sellers never brought together, the order is executed through dealers.||In this market, where the potential buyers and sellers come to a single platform and announce the prices which they are willing to buy and sell, which provides transparency and the best price to the security.|
There are several benefits associated with trading in the over the counter (OTC) market. However, this platform has some limitations which make this trading not suitable for certain investors.
- It is there is no third party involvement in trading. The dealers engage in buying and selling of securities using their own account.
- In this, there is quick and easy access to trading activity since the dealer is trading using his own account and it makes the entire process quick and easy. Time is an important factor while trading the securities, the amount of time taken for the price fluctuation is very minimal. A trader needs to act quickly, in order to make a maximum return from the transaction without wasting time.
- There is no centralized floor in the over the counter (OTC) market. The dealers can do the transaction electronically. It gives easy access to dealers who are located in different parts.
- Since there is no third party involvement, there is no point in brokerage and other fees and commissions.
- It allows the dealer to make research and provide support to investors using their own resources.
- This market has the ability to react quickly as per the market movements and grab the best opportunity and thereby minimize the loss.
- It requires more human intervention than other markets.
- The pricing of the stock may not be appropriate since there is no scope of bidding.
- Expertise knowledge of a specialist is necessary for some transactions. A specialist is the one who has experience and knowledge about the market and can utilize the opportunity better. This market cannot utilize a specialist’s expertise as there is no involvement of the third party.
- Stock trading is not common in the over the counter (OTC) market.
- Dealers are the market makers and there is a chance of manipulation and speculation.
Dealer Market is a secondary market, where a dealer, acts as the counterparty for buyers and sellers. The dealer, considered as a market maker, sets the bid price and investors, who are willing to accept the price can do the transaction. So it ensures liquidity in the market. Stocks are not commonly traded in this market, bonds and currencies are common securities traded in this market. It is a quote driven market. The dealer quotes two prices, Bid Price, which the dealer is willing to buy the security and Ask Price, which the dealer is willing to sell the security. The dealer makes a profit out of spread between Bid and Ask prices. They help to build liquidity in the market and uplift long term growth.
This has been a guide to what is Dealer Market and its definition. Here we discuss the example of over the counter (OCT) market along with its differences, advantages, and disadvantages. You can learn more about financial analysis from the following articles –