What Is a Dealer Market? Overview, Advantage, 10+ Facts

Dealer markets vary from general investment markets in that traders who specialize in certain commodities purchase and sell using their own accounts as opposed to being represented by a third party.

What Is a Dealer Market?

Multiple dealers advertise the prices at which they will purchase or sell a certain securities or instrument on a dealer market.

In a dealer market, a dealer (known 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”).

What Is a Dealer Market?

Bonds and foreign exchanges are typically traded on dealer markets, and Nasdaq stock trading is a classic example of an equity dealer market.

How Dealer Markets Work

A market maker (MM) in a dealer market risks their own capital to provide investors with liquidity. Therefore, the principal method of risk management for the market maker is the utilization of the bid-ask spread, which represents a physical cost to investors but is a source of profit for dealers.

Multiple market makers is the primary distinction between a dealer market and an auction market. At an auction market, a single specialist in a centralized location (for instance, the trading floor of the New York Stock Exchange) improves trade and liquidity by connecting buyers and sellers for a particular security.

Dealer Markets vs. Broker Markets

In order for a deal to occur on a broker market, a buyer and a seller must be identified. In a dealer market, buyers and sellers execute buy/sell orders individually and independently via market makers who are dealers. Also distinguishing between broker and dealer markets are:

  • Brokers conduct deals on behalf of third parties, whereas dealers execute trades in their own name.
  • However, dealers purchase and sell assets for their own interests.
  • Dealers have all the rights and freedoms to purchase and sell stocks, but brokers do not.
  • Brokers receive commissions for doing business, but dealers, as principals, do not receive commissions.

Example of a Dealer Market

For instance, if Dealer A has a large supply of WiseWidget Co. stock – which is listed on the Nasdaq market alongside other market makers at a national best bid and offer (NBBO) of $10 / $10.05 – then he or she will be able to sell the stock at a premium.

What Is a Dealer Market?

Suppose that Dealer A desires to dispose of some of its assets, so it posts its own bid-ask quotation of $9.95 / $10.03, which is skewed downwards due to the fact that it has a desire to sell.

Investors seeking to purchase shares of Widget Company would therefore accept Dealer A’s offer price of $10.03, which is two cents less than the $10.05 price given by other market makers. Similarly, investors wishing to sell WiseWidget Co.

shares would have little motivation to “hit the bid” of $9.95 set by Dealer A, given that it is 2 cents below the $10 price that other dealers are ready to pay for the stock.

What Is the Difference Between a Trader and a Dealer?

A dealer is a specialist sort of trader who undertakes to consistently create two-sided marketplaces for the assets in which they trade.

Therefore, they will always submit a bid and an offer. The objective is to transact with both buyers and sellers in the market often enough to create a profit on the bid-ask spread.

Traders, on the other hand, are not required to create two-sided marketplaces and are free to purchase or sell at will. Non-dealer traders are seen as price takers in this context (instead of market makers).

Traders do not profit from the bid-ask spread, but rather hope that the market will move in their favor so that they may exit the deal at a favorable price.

What Are the Types of Securities Dealers?

In the current financial markets, broker-dealers (BDs) are licensed firms that can trade securities both for their own accounts and on behalf of customers.

Some broker-dealers serve as agents (pure brokers), arranging deals on their clients’ behalf for a commission. Others trade against clients from their own accounts, acting as both principal and agent.

Thousands of broker-dealers fall into one of two major categories: a wirehouse, which sells its own goods, or an independent broker-dealer, which sells products from external sources.

What Is a Dealer Market?

What are Securities and Market Makers?

  • A security is a marketable asset that may be sold for financial advantage. Notably, securities are typically validated electronically and are classified as debt securities, equity securities, and derivatives.
  • A market maker is a financial institution that executes transactions and guarantees market liquidity. The market maker trades securities for their own account (primary trade) or for the account of their customer (agency trades).

Bid Price vs. Offer Price

In the dealer market, the dealer can serve as a “market maker” and establish a market by posting their bid and offer prices for securities.

  • Bid Price: The price the dealer is willing to pay to acquire the security.
  • Offer Price: The price at which a dealer is ready to sell his or her securities.

Bid-Ask Spread with Example

Market makers utilize the bid-ask spread, which represents the physical cost to investors, to manage possible risk.

The bid-ask spread is the difference between the ask price and the bid price of a market-traded financial instrument.

In simplest terms, it is the difference between the highest price a buyer is ready to pay and the lowest price a seller is willing to accept for a financial instrument. The bid-ask spread is depicted in the diagram below.

The bid-ask spread indicates the distance between two market players and a successful transaction.

For instance, the bid price of a security is $200, whereas its ask price is $215. In this situation, the bid-ask spread will be $15, as this is the difference between the price the buyer is prepared to pay and the price the seller is willing to accept.

Dealer Market vs. Auction Market

Dealer Market: Multiple dealers purchase and sell assets on their own accounts in this financial market.

Here are a few features of the dealer market:

  • Dealers function as market makers and determine the bid and ask prices.
  • Quote-driven — the dealer executes the transaction and provides market participants with a bid and offer price.
    The dealer facilitates the exchange of securities.
    Electronic trading eliminates the need for a centralized trading floor.
  • The primary components of a dealer market are foreign exchanges and bonds.

Auction Market: In contrast, the auction market is a financial market in which buyers and sellers of financial instruments participate in competitive auctions.

What Is a Dealer Market?

The auction market possesses the following characteristics:

  • Attending auctions are buyers and sellers.
  • Price quotations are determined by market players.
  • The completion of a deal is contingent upon the bid and offer prices of the market participant.
  • There is a single body in the auction market that oversees trade by matching the bid and offer prices of market participants to assure a transaction.
  • A central trade floor is present.
  • The auction market consists mostly of stocks.
  • The New York Stock Exchange serves as a model auction market (NYSE).

Advantages Of a Dealer Market

  • No third parties are involved in trade. Instead, dealers use their accounts to purchase and sell securities.
  • Since the dealer trades using his own account, access to trading activity is quick and simple, and the entire procedure is simple. In securities trading, time is a crucial aspect.
  • The period required for price fluctuations is really brief. A trader must move swiftly in order to maximize the profit from a deal and avoid wasting time.
  • In the Over-the-Counter (OTC) market, there is no centralized floor. Electronic marketing is available to dealers. It provides simple access to vendors in various regions.
  • Since there is no participation of a third party, brokerage fees and other commissions are unnecessary.
  • It enables the dealer to perform research and provide assistance to investors utilizing their resources.
  • This market is capable of reacting swiftly to market fluctuations, seizing the greatest chance, and minimizing loss.

What Is a Dealer Market?

Disadvantages Of a Dealer Market

  • It demands greater human involvement than other marketplaces.
  • Due to the absence of bidding, the stock’s price may not be suitable.
  • Certain transactions require the expertise of a specialist. A specialist has the knowledge and expertise in the market to capitalize on the opportunity more effectively. This market cannot utilize the skills of a specialist because there is no third party involved.
  • Over-the-Counter (OTC) market stock trading is uncommon.
  • Market makers are dealers, and there is the possibility of manipulation and speculation.

Conclusion

The dealer market is a secondary market in which dealers serve as counterparties for buyers and sellers. The offer price is established by the dealer, who is regarded as a market maker, and investors who are prepared to accept the price can engage in the transaction.

Thus, it ensures market liquidity. Bonds and currencies are the most regularly traded securities on this market, whereas stocks are not commonly traded.

The market is driven by quotations. The dealer provides two prices: the Bid Price, at which he or she is prepared to purchase the security, and the Ask Price, at which they are willing to sell the security.

FAQ

As formerly mentioned, an auction market trades directly between a buyer and a seller. A dealer market uses a middleman or “market maker,” who buys and sells securities to create liquidity in the market. The market makers are typically referred to as brokers and profit from the bid-ask spread.
(OTC) market
A dealer makes the market in securities by offering either buy or sell them at offer or bid price. It is also called (OTC) market.
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