What Is a Choice Market?

A choice market is a market in which the bid-ask spread for a given financial instrument is zero. Also known as a locked market, this is a rare and usually short-lived circumstance.

Key Takeaways

  • In a choice market, the bid-ask spread for a security is zero, meaning that a financial instrument can be bought for the same price it would cost to sell it.
  • A choice market, also called a locked market, is an unusual and typically short-term occurrence, as there is typically a spread between the bid price and ask.
  • Regulators see a choice market as violating market rules that require investors receive the next and best available prices when trading.
  • As such, the Securities and Exchange Commission banned locked markets in 2007, despite criticism that doing so slows innovation and makes it harder and more expensive for investors to buy securities.

Understanding a Choice Market

In a choice market, a financial instrument can be bought for the same price as it can be sold. Ordinarily, there is a difference between the highest price a buyer will pay for a security and the lowest price a seller will accept.

Choice markets are rare in financial markets, as most financial instruments trade with a spread between the bid and the ask. A choice market usually occurs when there is extreme liquidity in the markets and a limited number of intermediaries.

A choice market might occur, for instance, in an over-the-counter brokered market in which one side pays brokerage only, or when NASDAQ securities trade before the open.

A market that most closely resembles a choice market is Forex, or currency trading, in which some currency pairs trade with a spread of only a fraction of a percent. For example, the spread between the USD and EUR is usually only 1 basis point or 0.01 percent.

The SEC Ban on Choice or Locked Markets

The Securities and Exchange Commission (SEC) considers a choice or locked market to violate fair and orderly market rules, which requires that buyers and sellers receive the next and best available prices when trading securities. SEC regulations require national exchanges not to display a quote that indicates a locked market.

The SEC passed the Regulation National Market System in 2007, which banned locked markets in an effort to create a more orderly and competitive means for investors to transfer risk on the secondary market.

Policy critics argue that banning locked markets stifles innovation and the regulations do not achieve their intended effect. The ban on locked markets makes it more difficult and more expensive for investors to buy stocks. Instead, a securities information processor is likely to display incorrect bid-ask information for a given security. This can lead exchanges to decline orders because they are relying on inaccurate pricing information.

High-frequency traders may be able to get around locked market restrictions, allowing them to take advantage of the lag time between the stock bid and price changes and SIP updates. This can allow them to trade stocks at more advantageous prices than other investors trading the same stocks at the same exchange at the same time.

Special Considerations

Many analysts contend that a repeal of the ban on locked markets would be pointless due to the many other rules and regulations already in place. While some assert that a repeal of the ban on locked markets would eliminate many order types and make the market less complex, others argue that a repeal of the ban would lead to more crossed markets or markets in which bid prices are lower than asking prices.