The global securities market has been constantly evolving over the years to better serve the needs of traders and investors alike. Traders require liquid markets with minimal transaction and delay costs in addition to transparency and assured completion of the transaction. Based on these core requirements, a handful of securities market structures have become the dominant trade execution structures in the world.

Quote-Driven Markets

Quote-driven markets are electronic stock exchange systems where buyers and sellers engage in transactions with designated market makers or dealers. This structure only posts the bid and ask quotes for specific stocks dealers are willing to trade.

In a purely quote-driven market structure, traders must interact directly with dealers, who supply liquidity in the market. That's why this structure is well-suited for illiquid markets. Dealers can provide liquidity to securities by maintaining an inventory of those that are thinly traded or trade at low volumes. By providing liquidity, dealers make money from the spread between the bid and ask quotes. To generate profits, they try to buy low at the bid and sell high at the ask, and have high turnover.

Because dealers need to meet the bid and ask prices they quote, order execution on trades is guaranteed. Some dealers may refuse to make trades, however, as they may only work with special clients like institutional ones.

This market structure is commonly found in over-the-counter (OTC) markets such as bond markets, the forex market, and some equity markets. The Nasdaq and London SEAQ (Stock Exchange Automated Quotation) are two examples of equity markets which have roots in a quote-driven market structure. The Nasdaq structure, it is worth noting, also contains aspects of an order-driven market.

Quote-driven markets are also called dealer markets or price-driven markets.

Order-Driven Markets

In order driven markets, buyers and sellers post the prices and amounts of the securities they wish to trade by themselves rather than through a middleman like a quote-driven market.

Most order-driven markets are based on an auction process, where buyers are looking for the lowest prices and sellers are looking for the highest prices. A match between these two parties results in a trade execution. Order execution in this market structure is not guaranteed as traders are not required to meet the bid or ask prices they quote. Price discovery is determined by the limit order of traders in the particular security.

There are two main types of order-driven markets, a call auction, and a continuous auction market. In a call auction market, orders are collected during the day and at specified times an auction takes place to determine the price. A continuous market, though, operates continuously during trading hours with trades executed whenever a buy and sell order match up.

The biggest benefit of an order-driven market in liquid markets is the large number of traders willing to buy and sell securities. The larger the number of traders in a market, the more competitive the prices become. This theoretically translates into better prices for traders. Transparency is also a big benefit because investors have access to the entire order book. This is the electronic list of buy and sell orders for a specific security. The one major downfall with this structure is that liquidity can be poor in securities with few traders.

The Toronto Stock Exchange (TSX) in Canada is one example of an order-driven market.

Hybrid Markets

The third market structure we explore in this list is the hybrid market, also known as a mixed-market structure. It combines features from both a quote-driven market and an order-driven market, blending together a traditional floor broker system with an electronic trading platform — the latter being much faster. 

The choice is up to investors how they do business and place their trade orders. Choosing the automated electronic system means much faster trades which can take less than a second to complete. Broker-initiated trades from the trading floor, though, can take longer — sometimes as long as nine seconds.

The New York Stock Exchange (NYSE) is one of the world's leading hybrid markets. Originally an exchange that allowed human brokers to make trades manually on the trading floor, it moved beyond that after 2007, allowing the majority of stocks to be traded electronically. Brokers can still make trades manually, but the majority of trades today are executed through the exchange's electronic systems. The NYSE also continues to use dealers to provide liquidity, in the event of low liquidity periods.

Brokered Markets

The final market structure we'll look at in this article is the brokered market. In this market, brokers or agents act as middlemen to find buyers or counterparties for a transaction. This market usually requires the broker to have some degree of expertise in order to complete the sale or trade.

When a client asks their broker to fill an order, the broker will search their network for a suitable trading partner. Brokered markets are often only used for securities with no public market such as unique or illiquid securities, or both. Common uses of the brokered markets are for large block trades in bonds or illiquid stocks.

The direct real estate market is also a good example of a brokered market. This market contains assets relatively unique and illiquid. Clients generally require the assistance of real estate brokers to find buyers for their home. In these markets, a dealer wouldn't be able to hold an inventory of the asset, like in a quote-driven market, and the illiquidity and low frequency of transactions in the market would make an order-driven market infeasible, as well.

The Bottom Line

There are different types of market structures simply because traders and investors have different needs. The type of market structure can be very important in determining the overall transaction costs of a large trade. It can also affect the profitability of a trade. In addition, if you are developing trading strategies, sometimes the strategy may not work well across all market structures. Knowledge of these different market structures can help you determine the best market for your trades.