Quote-Driven vs. Order-Driven Markets: An Overview
Both quote- and order-driven markets refer to digital financial marketplaces—electronic stock (or bond, or other security) exchanges. The difference between these two market systems lies in what is actually displayed in terms of orders and bid and ask prices for the traded security.
- An order-driven market displays all the bids and offers for a security in the open marketplace or exchange.
- A quote-driven market only displays bids and asks of designated market makers and specialists for a specific traded security.
- Order-driven markets offer greater transparency, while quote-driven markets can offer more liquidity and a guarantee of order fulfillment as market makers are required to meet their quoted bid and ask prices.
An order-driven market is one in which all of the orders of both buyers and sellers are displayed, detailing the price at which they are willing to buy or sell a security, and the amount of the security that they are willing to buy or sell at that price.
So, if you place an order for 100 shares of ABC stock at $30 per share, your order will be displayed in the market and can be seen by people with access to this level of information (most exchanges charge fees for such access).
In the table below, all of the buy and sell orders are displayed for hypothetical ABC stock showing the price and share amount of the order. So, according to what we see in the table, someone could come into the market and buy 59,100 shares for $42.65 per share.
The biggest advantage of an order-driven market system is its transparency: It clearly shows the total of the market orders (also known as the order book) out there. The drawback is that there is no guarantee that these orders will actually be executed—that is, realized. They're just prices investors or traders desire to pay.
A quote-driven market, also known as a price-driven market or dealer's market, is more limited in scope. It only displays the bid and asks offers for a security from designated market makers, dealers, or specialists. These market makers will post the bid and ask price that they are willing to accept at that time. Quote-driven markets are most commonly found in markets for bonds, currencies, and commodities.
Let's go back to our hypothetical ABC stock. In this system, if there were one market maker for the stock, it would post its bid—say, $29.50—and its ask—say, $30.50. This would mean you could buy shares of ABC stock for $30.50 and sell shares for $29.50. That is all that would be displayed unless there was more than one market maker, in which case you could see more than one bid or ask on offer, and opt for those terms instead.
A security's bid and ask prices will change constantly depending on the supply and demand in the market.
As an individual investor (and not a dealer, market maker, or another designated party), your own order for 100 shares of ABC stock at $30 per share would not be posted in this system. The market maker will either fill your order from its own inventory or match you with another order. Of course, investors can try to negotiate better prices, either themselves or through their broker or agent.
The major advantage of a quote-driven market is its liquidity: The market makers are required to meet their quoted prices, either buying or selling. So, you have a guarantee of order fulfillment. The major drawback of the quote-driven market is that, unlike the order-driven market, it lacks transparency: Individual orders are not seen. There might be better offers out there, but you won't know about them.
There are systems that combine attributes from both the quote- and order-driven systems to form hybrid markets. For example, a market may show the current bid and ask prices of the market makers but also allow people to view all of the limit orders in the market. The New York Stock Exchange and Nasdaq are both considered hybrid markets.