It was the first of its kind, operating in a way that hadn’t been seen before. For generations, stock markets were real places where traders got together to buy and sell shares face-to-face. Then the NASDAQ opened, and everything changed. Though it wasn’t widely recognized at the time, this plucky new-style stock exchange would shift the way markets traded, and vastly improve the speed and accuracy of trades.
When it first launched in February 1971, the NASDAQ hosted only 250 companies. Its first claim to fame: the NASDAQ opened as the first fully electronic stock market in the world. Through the turbulent 1970s, the exchange began to grow, and it became a beacon for young computer-based start-up companies, many of which disappeared as fast as they came on the scene. By the 1980s, computers were gaining ground, and two groundbreaking companies issued IPOs, a powerful indication of what was to come. Those two companies, Apple Inc. (1980) and Microsoft Corporation (1986), changed everything, each eventually becoming (at least for a time) the biggest corporation in the world.
The exchange hit a milestone in 1996, when its trading volume finally exceeded 500 million shares per day. Suddenly, the NYSE wasn’t the only exchange hosting successful, respected companies. Now the NASDAQ has grown into a full-fledged stock market, listing about 3,200 corporations, and it’s destined to keep growing. Out of all the U.S. stock markets, the NASDAQ (which is now officially known as the NASDAQ OMX Group) hosts the most initial public offerings (IPOs), and it is drawing in more companies all the time.
The NASDAQ is attractive to new and growing companies primarily because the listing requirements are less stringent than those of the NSYE, and the costs of listing can be considerably lower. Not surprisingly, you’ll find a lot of technology and biotech stocks listed on this exchange, as these types of companies typically fall squarely in the aggressive growth category. In fact, the NASDAQ boasts more than $9.5 trillion total market value, most of that coming from the technology sector. To catch a glimpse of the companies listed on this exchange, take a look at the NASDAQ Composite, a comprehensive stock index that follows all of the corporations listed there (more on that in the NASDAQ Composite chapter).
The NASDAQ is a dealer market, which means its securities are traded by dealers through telephone and computer networks as opposed to being facilitated by specialists on a physical exchange floor.
Unlike the auction-style trading floor of the NYSE, the NASDAQ works with more than 600 securities dealers known as market makers. Market makers do just what it sounds like they do: they create a market for securities. They even put up their own capital in order to provide a liquid market for investors, making it easier for them to buy and sell shares.
Though the name seems to imply that market makers are individual traders, most are big investment companies (at least on the NASDAQ). That’s how they’re able to keep a large supply of stocks on hand that can be sold when orders are placed. There’s a lot of overlap in the companies that these market makers keep in inventory, which leads to robust competition. Because the exchange is fully computerized, market makers don’t conduct business face-to-face, or even over the phone. All trading on the NASDAQ is done electronically.
These market makers compete against one another to offer the best bid and ask prices (or quotes) over the NASDAQ’s complex electronic network, which joins buyers and sellers from all over the world. In fact, market makers must offer firm bid and ask prices, creating what’s called the “two-way” market (in FINRA terms). In other words, market makers have to trade shares at the bid and ask prices they have quoted. Between the two amounts is the bid-ask spread, the mathematical difference between the two quotes, and the spot where these market makers can make a lot of money. To level the playing field for investors, market makers are legally required to fill market orders at the best bid or ask price for the customer.
A NASDAQ Deal
Let’s walk through the way a deal on the NASDAQ goes down. It starts with the market maker entering bid and ask prices, say a bid/ask of $85.20/$85.25 for a share of Netflix. That means the market maker will buy shares for the bid price of $85.20 and sell shares at the ask price of $85.25. The difference between those bid and ask prices is five cents per share, and that represents the market maker’s profit, known as the spread.
This looks a little different from the investor’s perspective. With those quotes, an investor looking to sell at the current market price would receive $85.20 per share, while an investor looking to buy would pay $85.25 per share.