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What's the main difference between a specialist and a market maker? Not much. Both the New York Stock Exchange (NYSE) specialist and the Nasdaq market maker try to increase the liquidity on their respective exchanges and provide more fluid and efficient trading.
A specialist is a dealer representing a NYSE specialist firm - one of the main facilitators of trade on the exchange. A market maker is a broker-dealer who facilitates the trading of shares by posting bid and ask prices along with maintaining an inventory of shares. It is important to note that a specialist is a type of market maker. The NYSE has seven specialist firms while the Nasdaq has nearly 300 market makers. The NYSE is an auction-based market where traders meet on the floor of the exchange, using person-to-person, telephone orders or electronic orders. The Nasdaq, on the other hand, is strictly an electronic exchange.
NYSE
Specialists working on the NYSE have four roles to fulfill in order to ensure a fair and orderly market:
1.Auctioneer
Because the NYSE is an auction market, bids and asks are competitively forwarded by investors. These bids and asks must be posted for the entire market to see to make certain that the best price is always maintained. It is the job of the specialist to ensure that all bids and asks are reported in an accurate and timely manner, that all marketable trades are executed and that order is maintained on the floor. Along with posting the daily bid and ask prices, the specialist must also set the opening price for the stock every morning. This price can differ from the previous day's closing price based on after-hours news and events. The role of the specialist is to find the correct market price based on supply and demand.
2. Agent
The specialist can also accept limit orders relayed by investors through brokers or electronic trading. It is the responsibility of the specialist to ensure the order is transacted appropriately on behalf of others, using the same fiduciary care as the brokers themselves once the price of the stock has reached the limit criteria.
3. Catalyst
Because the specialists are in direct contact with the bidders and sellers of particular securities, it is their responsibility to ensure that enough interest exists for a particular stock. This is carried out by specialists seeking out recently active investors in cases where the bids and asks can't be matched. This aspect of the specialist's job helps to induce trades that may not have happened if the specialist had not been there to bring buyers and sellers together.
4. Principal
In the instance where there's a demand-supply imbalance in a particular security, the market maker must make adjustments by purchasing and selling out of his or her own inventory to equalize the market. If the market is in a buying frenzy, the specialist will provide shares from until the price is stabilized. A specialist will also buy shares for his or her inventory in the event of a large selloff.
Nasdaq
Market makers working on the Nasdaq exchange are not actually at the exchange. They are large investment companies that buy and sell securities through an electronic network. These market makers maintain inventories and buy and sell stocks from their inventories to individual customers and other dealers.
Each market maker on the Nasdaq is required to give a two-sided quote, meaning they must state a firm bid price and a firm ask price that they are willing to honor.
Each security on the Nasdaq generally has more than one market maker, with an average of 14 market makers for each stock; this provides liquidity and efficient trading. The market makers are openly competitive and facilitate competitive prices; as a result, individual investors generally will get the best price. As this competition is evident in the limited spreads between posted bids and asks, the market makers on the Nasdaq will in some instances act very much like the specialists on the NYSE.
(For further reading, see Understanding Order Execution and/or The Tale Of Two Exchanges: NYSE And Nasdaq.)
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