What Is the Third Market?

A third market consists of trading conducted by non-exchange member brokers/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 brokers/dealers and large institutional investors.

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.

Understanding the Third Market

The third market supports the primary and secondary markets. The primary market describes the issuance of new securities. The secondary market is traditionally where seasoned securities are exchanged among market participants. And now, the third market is ancillary to the secondary market, with an emphasis on OTC markets and institutional investors.

How the Third Market Works

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 logics 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, although, 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.