The Nasdaq Stock Market is a computerized communication system that provides the bid and asked prices of more than 5,000 over-the-counter (OTC) stocks that have met the market's registration requirements. Originally known as the National Association of Securities Dealers Automated Quotations system, the name was changed in 1990 to the Nasdaq Stock Market, commonly referred to simply as Nasdaq. Introduced in 1971 by the National Association of Securities Dealers (NASD), Nasdaq enjoyed explosive growth during the 1980s and 1990s. From 1983 to 1993 Nasdaq grew from $153 billion in annual trading volume and 4,097 listed companies, to $1.3 trillion in annual trading volume and 4,861 listed companies. In mid-1995 the market capitalization of listed firms on Nasdaq surpassed $1 trillion.
By late 1997 Nasdaq had approximately 5,500 listed companies, compared to some 3,000 listed on the New York Stock Exchange (NYSE). Even though Nasdaq had many more listed firmns than the NYSE, market capitalization of NYSE-listed firms was around $8.7 trillion in late 1997 compared to $1.95 trillion for Nasdaq-listed firms. Nasdaq has been known as the market for smaller companies and especially for technology firms. Approximately 35 percent of Nasdaq's 1997 market capitalization came from technology companies.
Trading volume on Nasdaq surpassed that of the NYSE sometime in 1994. For the first eight months of 1997, average trading volume on Nasdaq was 696 million shares, compared to 513 million shares on the NYSE. From 1982 to 1992 Nasdaq increased its share of stock trades from 32 percent to 47 percent, while the NYSE's share of trading dropped from 63 percent to 50 percent.
OTC stocks are traded differently than stocks that are listed on the NYSE or the American Stock Exchange (AMEX). Stocks listed on the NYSE or AMEX are traded using the auction method. In the auction method, specialists handle all trades in specific stocks and either passively match orders from buyers and sellers or take a position in the stocks themselves. OTC stocks, on the other hand, are traded using a multiple market maker system. There are approximately 500 member firms that make markets in OTC stocks traded on Nasdaq. Some stocks may have 60 market makers, while smaller stocks may have only two. The multiple market maker system, it is argued, provides companies with greater liquidity than the auction system.
Under the multiple market maker system, dealers make markets in OTC stocks by making bids to buy and offers to sell. A dealer's bid price is the highest price at which someone would buy a stock, and the asked price is the lowest price at which someone would sell the stock. The difference between the market's bid and asked prices is known as the bid-asked spread.
The bid-asked spread, which can range from an eighth of a point ($.125) to half a point ($.50) per share, results in an additional trading cost for investors. Since 1996, when the Securities and Exchange Commission (SEC) accused Nasdaq's market makers of colluding to set prices, spreads have declined. During 1997 there was a 30 percent decline in spreads due to new SEC rules, which resulted in savings to investors of an estimated $1.3 billion in trading costs.
Prior to the introduction of Nasdaq in 1971, bidasked prices were circulated using daily "pink sheets" that were issued by the National Quotation Bureau in three regional editions (East, Midwest, West). During the trading day there was no centralized data on bid and asked prices. Trading in the OTC market was slower, and the bid-asked spreads were higher than under Nasdaq. Nasdaq facilitated OTC trading by providing continuous, up-to-the-minute quotations on bid and asked prices through a centralized computer system.
The approximately 500 member firms that trade on Nasdaq do so using computers and telephone lines. Unlike the NYSE, there is no trading floor where dealers gather to execute their transactions. Rather, it is all done electronically. In some cases trades can be executed without individual dealers calling each other on the telephone.
Nasdaq offers its dealers three levels of service. Level One service provides bid and asked prices in all securities to all salespersons and dealers through approximately 200,000 terminals. It also provides sales price and volume information on the OTC stocks included in Nasdaq's National Market System. The terminals are usually leased by subscribers from vendor firms such as Quotron. Level Two service utilizes Nasdaq-owned terminals to provide subscribers with a variety of information on the OTC market. Level Three service allows registered market makers to report their trades and daily volume as well as to receive Level Two service.
Other dealer services offered by Nasdaq include the Small Order Execution System (SOES). For trades involving 1,000 shares or less of stocks listed on Nasdaq's National Market System, or 500 shares or less for other Nasdaq issues, trades can be executed electronically under SOES without any telephone calls between dealers. Nasdaq also offers Trade Acceptance and Reconciliation Services, which assists member firms in resolving their uncompared and advisory OTC trades.
Not all securities that trade over-the-counter are listed on Nasdaq. In order to be listed on Nasdaq a common stock must be registered under section 12(g) of the Securities Exchange Act of 1934, or the equivalent, and must also meet minimum levels for total assets, capital and surplus, public float, number of dealers, and number of shareholders. Those OTC securities that are not listed on Nasdaq trade infrequently and continue to rely on "pink sheets" to disseminate information on their bid and asked prices.
A merger between Nasdaq and AMEX was completed in November 1998 after it was approved by AMEX members. The two exchanges would continue to be run separately by a newly formed unit, the Nasdaq-AMEX Market Group. The new Nasdaq-AMEX planned to build a globally linked marketplace.
[ David P. Bianco ]
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