What Is a Crossed Market?
A crossed market is the name traders and market makers give to a circumstance where a market's bid price exceeds its ask price. This is an unusual circumstance made even rarer with the advance of electronic and computerized trading.
- A crossed market order occurs when a bid price exceeds an ask price resulting in unfavorable terms for the market maker.
- Crossed markets usually happen during extremely fast trading conditions in volatile markets, or extremely slow movement in illiquid markets that may create situations where bid prices are higher than ask prices temporarily.
- Crossed markets are rare and even more so with advances in electronic trading.
Understanding Crossed Markets
Typical order processing in financial markets is based on two continuously changing prices, the bid price, and the ask price. Modern markets almost always have some individuals or entities that take the role of a market maker, trying to match buyers and sellers. Market makers account for a substantial percentage of the trading volume and work to keep markets orderly and attractive. They make money based on trading volume because they only profit based on the difference between the bid and the ask price in the markets. If they can buy at the bid and sell at the ask, and do so hundreds or thousands of times each day, their compensation is worth the risk they take.
The only serious risk they take is if they cannot make the bid-ask spread on their trades. At rare moments certain circumstances arise where they cannot make money on the trade. A crossed market order occurs when a bid price exceeds an ask price resulting in unfavorable terms for the market maker.
Bid and Ask Spreads
Bid and ask quotes are a central part of all exchanges. They allow two entities to trade in the open market. Market makers facilitate this trading which can be done by exchange traders or through technology platforms. The advances in order-processing technology use computer assistance to match buyers and sellers in milliseconds and rarely create cross-market conditions.
Multiple exchanges exist across the market that facilitate trading in this way through bid and ask matching. Exchanges include NYSE, Nasdaq, ARCA, AMEX, and CBSX. Electronic communication networks (ECNs) also exist across the market to serve as market makers as well. All of these use a bid and ask price defined in the following ways:
- Bid: A bid quote represents the price that a market maker seeks to buy a security. The number of shares a market maker is seeking is also included with the bid.
- Ask: The ask price quote represents the price that a market maker is willing to sell a security. An ask price is also associated with a specific number of shares.
Crossed Market Discrepancies
Crossed markets rarely occur in modern markets. The two circumstances where they are likely to occur are extreme situations. Either extremely fast trading conditions in volatile markets, or extremely slow movement in illiquid markets may create situations where bid prices are higher than ask prices temporarily.
Fast trading can occur in times when many market participants are selling in a panic. At such times prices drop precipitously and computer algorithms kick in and begin automated buying. This creates rapid swings in price, sometimes even sub-second movements in price occur. During such times the bid price may be unnaturally held above the ask price.
For market makers to step in to try to calm this market they may have to commit to instantly losing money on a trade. Because this is prohibitive, most market makers will not step into such circumstances unless the exchange requires them to do so. When market makers do not step into the trading, it may add to the volatility and only make conditions worse.
Crossed market orders can also refer to scenarios on a comparable exchange. Any time the security’s bid price exceeds the ask price it is considered a crossed market order.