Dealer Market

What Is a Dealer Market?

A dealer market is a financial market mechanism wherein multiple dealers post prices at which they will buy or sell a specific security or instrument. In a dealer market, a dealer (who is designated as a “market maker”) provides liquidity and transparency by electronically displaying the prices at which it is willing to make a market in a security, indicating both the price at which it will buy the security (the “bid” price) and the price at which it will sell the security (the “offer” price).

Bonds and foreign exchanges trade primarily in dealer markets, and stock trading on the Nasdaq is a prime example of an equity dealer market.

Key Takeaways

  • A dealer market is a transparent financial market mechanism in which multiple dealers post the prices they are willing to buy or sell a specific security.
  • Bonds and foreign exchanges trade primarily in dealer markets.
  • Some stock exchanges like the Nasdaq operate as equity dealer markets.
  • Notably, dealer markets stake the capital of a dealer to provide liquidity to investors and remove the middle man, the broker, from transactions.
  • Dealer markets can be contrasted with auction markets and brokered markets.
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Dealer Market

How Dealer Markets Work

A market maker (MM) in a dealer market stakes his or her own capital to provide liquidity to investors. The primary mode of risk control for the market maker is, therefore, the use of the bid-ask spread, which represents a tangible cost to investors, but which is also a source of profit to dealers.

A dealer market differs from an auction market primarily in this multiple market maker aspect. In an auction market, a single specialist in a centralized location (think of the trading floor on the New York Stock Exchange, for instance) facilitates trading and liquidity by matching buyers and sellers for a specific security.

Dealer Markets vs. Broker Markets

In a broker market, there must be a defined buyer and seller for a trade to happen. In a dealer market, buyers and sellers execute buy/sell orders separately and independently through dealers, who act as market makers. The differences between broker and dealer markets also include:

  • Brokers execute a trade on behalf of others, while dealers execute trades on their own behalf.
  • Brokers buy and sell securities for their clients, but dealers buy and sell on their own accounts.
  • Brokers don't have the rights and freedoms to buy or sell securities, but dealers have all those rights to buy and sell.
  • Brokers get commissions for transacting business, but dealers do not get commissions since they are primary principals.

Example of a Dealer Market

For example, if Dealer A has ample inventory of WiseWidget Co. stock – which is quoted on the Nasdaq market along with other market makers at a national best bid and offer (NBBO) of $10 / $10.05.

Say that Dealer A wishes to offload some of its holdings, so it posts its own bid-ask quote as $9.95 / $10.03, skewing it lower since they have an axe to sell.

Investors looking to buy WiseWidget Co. would then take Dealer A’s offer price of $10.03 since it is two cents cheaper than the $10.05 price at which it is offered by other market makers. At the same time, investors looking to sell WiseWidget Co. stock would have little incentive to “hit the bid” of $9.95 posted by Dealer A, since it is 2 cents less than the $10 price that other dealers are willing to pay for the stock.

What Is the Difference Between a Trader and a Dealer?

A dealer is a specialized type of trader who commits to continuously make two-sided markets in the securities that they deal in. This means that they will always be posting both a bid and an offer. The goal is to trade frequently enough with both buyers and sellers in the market to generate profit from the bid-ask spread.

Traders, on the other hand, need not make two-sided markets and can buy or sell as they please. In this respect, non-dealer traders are considered to be price takers (instead of market makers). Traders do not profit from the bid-ask spread, but instead hope for the market to move in their favor in order to exit the trade at a favorable price later on.

What Are the Types of Securities Dealers?

In today's financial markets, broker-dealers (BDs) are regulated entities that can engage in securities trading for both their own accounts and on behalf of clients. Some broker-dealers act as agent (pure broker), facilitating trades only on behalf of customers and taking a commission. Others act as both principal and agent, trading against customers from their own accounts.

There are thousands of broker-dealers falling into one of two broad categories: a wirehouse, which sells its own products, or an independent broker-dealer, which sells products from outside sources

Is Robinhood a Dealer Market?

No. Robinhood, like other online trading platforms, is a broker. As a broker, it is registered as a broker-dealer with FINRA, but it executes trades only on behalf of customers and does not take the other side of those trades. Nor does not constitute its own marketplace or exchange.

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