A Complete "How To" Guide for investing in Stocks, Bonds and Mutual Funds

How are shares bought and sold on the NASDAQ?

To help understand the NASDAQ system of trading, we'll go back 30 years. Companies that were too small to be listed and traded on the New York or the American Stock Exchanges were bought and sold by securities dealers in a market known as "over the counter", or OTC. They were called this because they were not traded on the "floor" of an exchange.

If an investor asked his or her broker to buy shares in a company, the broker would call a few dealers, known as market makers, finding the best price for the customer. If the investor asked the broker to sell his shares, the broker would call the same market makers trying to get the highest price for his client.

In February 1971, the National Association of Securities Dealers unveiled a computerized quote system where each dealer could post his buy and sell prices on the stocks he dealt in. He would also post the number of shares he is willing to buy or sell at the posted price. Called the NASDAQ, just 100 companies were initially automated.

The market maker (securities dealer) buys and sells stock, dealing directly with your broker. If more investors are currently selling, the market maker lowers his bid price, and the stock price moves down. If more investors are currently buying than selling, the market maker takes advantage of the moment by asking more for shares from his inventory, and so the price moves up.

Since each dealer is competing with others for the same trades, the price moves up or down only a few cents at a time. The difference between what a dealer is bidding (buying) and asking (selling) is called the spread, typically 3 to 10 cents, but can be much more on a stock with low trading volume (thinly traded).

Each dealer changes his prices throughout the day, depending on the changing volume and ratio of buyers to sellers. He quickly changes his prices to adjust for the moment's buying or selling trend. It's really quite simple. Securities dealers want to buy at the lowest competitive price, and sell to you at the highest price you will pay.

This buying and selling goes on all day long, with the last trade by 4:03 EST establishing the day's closing price. The NASDAQ also offers after-hours trading until 6:30 PM, and again an hour in the morning before the markets open at 9:30.

The current price for a stock is the share price of the last trade. When an investor places an order to buy or sell, however, the price has usually moved up or down by the time the order physically reaches the dealer that your broker is routing it to. Knight Trading (the largest market maker) pays Ameritrade an average $1.41 per trade. Knight Trading was fined by the SEC in late 2001 for illegally not honoring posted ask and bid prices.

The same stock can have different prices offered by different market makers at the same time. Most brokers don’t look for the best price, but favor preferred market makers or sell from their own portfolios.

You can tell where a stock is traded, on the NASDAQ or the New York Stock Exchange by just looking at the stock symbol.

If it has 1 to 3 characters like “F” for Ford or “DIS” for the Walt Disney Company, it is traded on the NYSE (or on the AMEX). If 4 or 5 characters, the stock is traded on the NASDAQ.