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What is the Dealer Market?
A dealer market is where dealers buy and sell a specific financial instrument electronically using their accounts. In addition, without involving a third party, make the market by quoting the offer price (price at which they are ready to sell) and bid price (price at which they prepare to buy).
A dealer in this market is referred to as a market makers because they offer the securities for buying or selling at the bid or offer price. As a result, the market provides greater liquidity to investors. It comprises many market makers connected through a telecommunication network; it does not 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 (OTC) market.
Key Takeaways
- A dealer market is where dealers buy and sell a particular financial instrument electronically utilizing the accounts. In addition, without involving a third party, one makes the market by quoting the offer price (price at which they are willing to sell) and bid price (price at which they are ready to buy).
- It is referred to as market makers because they provide the securities for buying or selling at the bid or offer price.
- The dealer market is also a secondary market where the dealer acts as the counterparty for buyers and sellers.
- Moreover, they help build market liquidity and elevate long-term growth.
Example of Dealer Market
Bonds and foreign exchanges primarily trade in the Over-the-Counter (OTC) market. NASDAQ (National Association of Securities and Dealer Automated Quotation System) is a prominent dealer market in equity stocks. The NASDAQ system, founded in 1971 as part of the Over-the-Counter (OTC) market, is now considered a separate entity. In this market, a buyer and seller are never together. Instead, their orders are (buy/sell) executed through the dealers' market makers.
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Dealer Market vs. Auction Market
An auction market is a trading platform where buyers and sellers come together and enter bids and offers. The transaction happens when buyers and sellers agree on a price.
| Dealer Market | Auction Market |
|---|---|
| A financial market where dealers buy and sell securities using their accounts. | A market where the buyers and sellers enter competitive bids and offers, respectively, simultaneously. |
| The dealer is considered a market maker and quotes the bid and offer prices of the securities and makes the market security. Investors who accept the prices can do the transaction electronically. | The potential buyers and sellers meet on a common platform in an auction market. They enter the competitive offer and bid prices, and the trade is 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 Quotations) system is a dealer market. | NYSE (New York Stock Exchange) is an example of the auction market. |
| There are multiple dealers in this market. | A single specialist in an auction market controls liquidity and trading activity by pairing the matching bids and offers. |
| The dealer holds the securities stock in this market and electronically quotes the offer and bid price. The buyers and sellers are never brought together; the order is executed through dealers. | In this market, the potential buyers and sellers come to a single platform and announce the prices they are willing to buy and sell, which provides transparency and the best price for security. |
Several benefits are associated with trading in the Over-the-Counter (OTC) market. However, this platform has some limitations, making this trading unsuitable for certain investors.
Advantages
- There is no third-party involvement in trading. Instead, the dealers buy and sell securities using their accounts.
- There is quick and easy access to trading activity since the dealer is trading using his account, making the entire process quick and easy. Time is an important factor while trading securities. The amount of time taken for the price fluctuation is very minimal. A trader needs to act quickly 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 marketing electronically. It gives easy access to dealers 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 conduct research and support investors using their resources.
- This market can react quickly to market movements, grab the best opportunity, and minimize the loss.
Disadvantages
- It requires more human intervention than other markets.
- The pricing of the stock may not be appropriate since there is no scope for bidding.
- Expert knowledge of a specialist is necessary for some transactions. A specialist has the experience and learning about the market and can utilize the opportunity better. This market cannot use a specialist’s expertise as the third party has no involvement.
- 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.
Conclusion
The dealer market is a secondary market where the dealer acts as the counterparty for buyers and sellers. The dealer, considered a market maker, sets the bid price, and investors 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 sold. 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 ready to sell. The dealer makes a profit from the spread between the bid and ask prices. They help to build liquidity in the market and uplift long-term growth.
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Frequently Asked Questions(FAQs)
Dealers use historical sales records, demand and supply for the vehicle, and the ability to elevate prices to estimate how much to impose a charge for a market adjustment. However, no specific industry standard exists; no law mentioning a dealer must justify the amount.
In the dealer market, information is primarily acquired by market participants such as dealers, market makers, and institutional investors. They maintain an inventory of securities and stand ready to deal with them at a quoted price.
Dealers play the market maker's role and fix bid prices/offer prices. They execute the order, produce a bid, and offer a fee for the market participants. The securities exchange is performed through the dealer.
Risks in this market include price fluctuation, counterparty risks, and market manipulation risks. Investors need to understand these risks and carefully evaluate the credibility and reliability of the dealers they engage with.
