What is the 'National Market System - NMS'

The National Market System (NMS) is the system for equity trading and order fulfillment in the U.S. It consists of trading, clearing, depository, and quote distribution functions. The NMS governs the activities of all formal U.S. stock exchanges and the Nasdaq market.

BREAKING DOWN 'National Market System - NMS'

The National Association of Securities Dealers (NASD) and the Nasdaq oversee the National Market System, which was created by the Securities Acts Amendments of 1975. The NMS governs exchange-based trading, such as on the New York Stock Exchange, and OTC trading on the Nasdaq. For practical purposes, the Nasdaq is considered an exchange, even though the negotiations occur directly among market markers.

To facilitate the fair distribution of information, the NMS requires that exchanges make bids and offers available and visible to all buyers and sellers. The advantages are an increase in liquidity and better prices. However, the system makes it difficult for institutions and large investors to execute large trades unnoticed. Some people argue that this visibility has pushed such trading off-exchange, fueling the expansion of private exchanges, called dark pools.

National Market System vs. Other OTC

Nasdaq is the highest of four levels of over-the-counter trading where companies must meet specific strict criteria of capitalization, profitability, and trading activity. Also, Nasdaq provides more comprehensive intraday trading information that is available for the lower levels of OTC stocks. Information includes last-sale prices, daily high and low prices, cumulative volume, and bid and ask quotes. Here, market makers must report actual transacted prices and share sizes within 90 seconds of the transaction. This requirement contrasts with the non-real-time reporting for non-NMS, lower tier OTC stocks.

The Nasdaq, while still a decentralized system for over-the-counter stock trading, is a virtual exchange with all the regulations, requirements, and safeguards which come with clearing houses. Other OTC markets have considerably fewer rules and safeguards.

OTC markets break down into three tiers, called the OTCQX, OTCQB and Pink Sheets. Listing requirements decrease with each level. Also, all of these markets are less stringent than exchanges covered by the National Market System.

Reg NMS

The Securities and Exchange Commission (SEC) saw a need to strengthen the NMS and account for changing technology. In 2005, they issued the Regulation National Market System (Reg NMS) which contains four main components.

  1. The Order Protection Rule aims to guarantee investors get the best price at the execution of their order. The rule removes the ability to have orders traded through or executed at a worse price.
  2. Improved access to quotations from trading centers in the NMS is due to the Access Rule. The rule requires greater linking and lower access fees.
  3. The Sub-Penny Rule provides for uniform quotes by setting the increment to nothing less than one cent. The rule applies to all stocks listed at over $1.00 per share.
  4. Market Data Rules allocate revenue to self-regulatory organizations that promote and improve market data access.

Probably most important of these rules was the order protection, or trade through, provision. Trade executions are provided at the best price, no matter where that lowest price is available.

Critics complained that it requires traders to transact on a trading venue that had the lowest price, even though they would prefer doing business on the site with the fastest execution or the best reliability. The feeling was that it would result in worse outcomes for institutional orders with all costs factored in.

RELATED TERMS
  1. Regulation NMS

    Regulation NMS is a set of rules that looks to improve the U.S. ...
  2. Normal Market Size

    Normal market size is a share classification structure based ...
  3. Order Protection Rule

    The Order Protection Rule is a policy that aims to ensure that ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) trades securities that are listed off ...
  5. Over-The-Counter Market

    An Over-The-Counter (OTC) Market is a decentralized market where ...
  6. OTC Pink

    OTC Pink is the lowest tier of the three marketplaces for trading ...
Related Articles
  1. Insights

    If You Buy Stocks Online, You Are Involved in HFTs

    Many people don't realise that some half to two-thirds of all trades use high-frequency trading in some fashion.
  2. Trading

    The Global Electronic Stock Market

    The way trading is conducted is changing rapidly as exchanges turn toward automation.
  3. Insights

    How Nasdaq Makes Money

    NASDAQ provides a marketplace which offers money-making opportunities to investors. Investopedia explains how NASDAQ makes money.
  4. Insights

    The NYSE and Nasdaq: How They Work

    Learn some of the important differences in the way these exchanges operate and the securities that trade on them.
  5. Trading

    Basics of the Mechanics Behind Electronic Trading

    Once associated with shouting traders and wild hand gestures, now statistics and programmers rule.
  6. Investing

    Introducing pink sheets: the OTC market

    Learn about pink sheets and how this electronic over-the-counter market trades stocks. Find out about the advantages and risks associated with pink sheets.
  7. Trading

    Automated Trading Systems: The Pros and Cons

    Automated trading systems minimize emotions, allow for faster order entry, lead to greater consistency and resolve "pilot error."
  8. Personal Finance

    A Day In The Life Of A System Trader

    Systems traders divide their time between trading, developing, backtesting, optimizing and forward testing, to create viable and high-probability trading systems.
RELATED FAQS
  1. How do I buy an over-the-counter stock?

    Buy and sell orders of over-the-counter (OTC) securities take place through market makers who carry an inventory of securities ... Read Answer >>
  2. What are the risks involved in OTC (over-the-counter) trading?

    Learn about the significant disadvantages and risks that are involved for investors seeking to trade in over-the-counter ... Read Answer >>
  3. How Does a Company Get Listed on the OTCBB?

    Learn about the stipulations for companies quoted in the over-the-counter bulletin board (OTCBB) service as over-the-counter ... Read Answer >>
  4. Move from an OTC to a major exchange

    In order to move a company from over-the-counter market to a major exchange, a number of conditions must be met to being ... Read Answer >>
Trading Center