What Is the Third Market?

A third market consists of trading conducted by non-exchange member broker-dealers and institutional investors of exchange-listed stocks. In other words, the third market involves exchange-listed securities that are being traded over-the-counter between broker-dealers and large institutional investors.

The term "over-the-counter" typically refers to the trading of securities that are not listed on widely-recognized exchanges such as the New York Stock Exchange (NYSE). These securities are instead traded through a broker-dealer network, as the securities don't meet the listing requirements of a centralized exchange. In the case of the third market, the securities are exchange-listed, but they are not being traded through the exchange.

Key Takeaways

  • With a third market, exchange-listed securities are traded by investors operating outside a centralized exchange through a network of broker-dealers and institutional investors.
  • Institutional investors, such as investment firms and pension plans, tend to participate in the third market, as do traders in the over-the-counter markets.
  • With over-the-counter markets, securities that are not qualified for listing on traditional exchanges are bought and sold through a network of broker-dealers.
  • Securities can often be purchased at lower prices in the third market because there are no broker fees.

How the Third Market Works

When hearing news about the financial markets, most investors have heard of the primary and secondary markets, but there is a third market as well. The primary market describes the issuance of new securities, such as an IPO or initial public offering of a new stock or security. The secondary market is traditionally where stocks and securities are traded, which is the market most investors are familiar with and execute their trades.

The third market is a marketplace or venue in which brokers and institutional investors, such as fund managers, can trade securities that are exchange-listed and are usually traded on a formal exchange such as the NYSE. When these exchange-listed securities and shares are traded in the third market, investors bypass the secondary market and the exchanges.

Before selling exchange-listed securities to a non-member in a third market transaction, a member firm must fill all limit orders on the specialist's book at the same price or higher. Typical institutional investors who take part in the third market include investment firms and pension plans. The third market brings together large investors willing and able to purchase and sell their own securities holdings for cash and immediate delivery. Securities can be purchased at lower prices in the third market because of the absence of broker's commissions.

Third-party trading systems bypass traditional brokers and allow large and possibly rival institutions' block orders to "cross" with each other. Anonymity rules prevent either side from knowing the identity of the counter-party. There are additional rules and logic built into flow management interfaces, but there is some information that cannot be shared with the public, which gives the transaction sufficient anonymity.

Third-market trading began in the 1960s with firms such as Jefferies & Company, though today there are a number of brokerage firms focused on third market trading.

Third Market Makers

Third-market makers add liquidity to financial markets by facilitating buy and sell orders even if there isn't a buyer or seller immediately available for the other side of the transaction. Third-market makers make a profit from their roles as intermediaries by buying low and selling high. They also place trades for brokers on exchanges of which that broker is not a member.

A third-market maker might act as a buyer when an investor wants to sell but just wants to make a small, short-term profit from buying a security at a favorable price and selling it to another investor at a higher price. Third-market makers sometimes pay brokers a small fee of a cent or two per share to direct orders their way. Sometimes brokers and third-market makers are one and the same.