What Is a Negotiated Market?
A negotiated market is a type of secondary market exchange in which the prices of each security are bargained out between buyers and sellers. In a negotiated market, there are no market-makers or order matching. Instead, buyers and sellers actively negotiate on the price at which a transaction is finalized either directly or through the use of brokers. These markets are considered very inefficient as the time, effort, and lack of transparency in pricing are large issues that can't be resolved for this type of trading.
- A negotiated market is a type of secondary market exchange in which the prices of each security are bargained out between buyers and sellers.
- In a negotiated market, there are no market-makers or order matching.
- Buyers and sellers actively negotiate on the price at which a transaction is finalized either directly or through the use of brokers.
- Buyers produce demand for a given security or asset by entering bid orders to buy the security at a specified amount and price; sellers create the supply for the security by entering ask orders, again for set amounts and prices.
Understanding a Negotiated Market
A negotiated market refers to the decentralized buying and selling of securities without one central market maker. Negotiated markets exist and function via the basic principle of supply and demand. Buyers produce demand for a given security or asset by entering bid orders to buy the security at a specified amount and price; sellers create the supply for the security by entering ask orders, again for set amounts and prices. The over-the-counter securities market is one major example of a negotiated market.
For example, consider a buyer who wants to buy 1,000 shares of the Small Time Insurance Company. This company is traded exclusively in the over-the-counter market. The buyer calls his broker and asks for a price quote. The broker checks the market by referring to the pink sheets issued by the National Quotation Bureau. The pink sheets indicated that a brokerage in Chicago is currently making a market in Small Time Insurance Company, quoting it at $20 bid and $20.75 asked. The broker tells the buyer that Small Time Insurance Company can probably be purchased for $20.75. If the buyer likes the price, he may give the broker an order to buy Small Time Insurance.
At this point, the buyer's broker would call or wire the broker in Chicago. Such a conversation might go like this:
- Buyer broker: What is your market for Small Time Insurance?
- Chicago broker: 20 bid and 20.75 asked
- Buyer broker: What is the size of your market?
- Chicago broker: 300 shared either way (buy or sell)
- Buyer broker: I will pay 20.25 for 100
- Chicago broker: I will sell 100 at 20.50
- Buyer broker: I will take 100 at 20.5
- Chicago broker: I have sold you 100 shares of Small Time Insurance common stock at 20.50
In practice, the buyer broker probably checked the quotations of several dealers before making an offer, since various brokers may be willing to sell a security at various prices. A broker that wants to buy a security for a customer will check the market by telephoning several brokers he thinks are making a market in the security.
Negotiated Market vs. Auction Market
A negotiated market can be contrasted to an auction market. In an auction market, buyers and sellers enter competitive bids simultaneously. The price at which a stock trades represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to accept. Matching bids and offers are paired together, and the orders are executed.
For example, suppose that four buyers wish to purchase shares of the company FUN. They make the following bids: $20.00, $20.02, $20.03, and $20.06. At the same time, four sellers want to sell shares of FUN, and these sellers submitted offers of $20.00, $20.02, $20.03, $20.06, respectively. In this scenario, the individuals that made bids/offers for FUN at $20.06 will have their orders executed. All remaining orders will not immediately be executed, and the current price of company FUN will be $20.06.
The New York Stock Exchange (NYSE) is one example of an auction market while the Nasdaq is an example of a negotiated market.