Founded in 1971, NASDAQ is an acronym for the National Association of Securities Dealers Automated Quotations system. It was the first computerized stock market and is still the largest. The NASDAQ is also a stock index, which means that it only measures OTC stocks, or stocks traded over the counter.
The computer network of the NASDAQ provides instant information to NASD members — and through them, to the rest of the world — about securities and prices in the OTC market and other negotiated trades. More than a half million computer terminals worldwide are connected to the NASDAQ network. In this way, NASDAQ quotations provide some of the same immediate market feedback that traders on an exchange floor get from outcry auctioning.
Throughout much of the 1970s and 80s the NASDAQ was of little interest to the general investing public, mostly because when a company grew large its management would pull their company’s stock from the NASDAQ in favor of a large exchange, such as the NYSE. That trend changed a number of years ago, when many of America’s newest growth companies bucked trend by remaining with the NASDAQ even after significant growth. Today many of the world’s largest companies — including Microsoft, Dell Computer, Intel, and Cisco — are on the NASDAQ. As a result, NASDAQ represents much of the investor wealth in the world.
The NASDAQ is what’s known as a weighted index; this means that stocks with larger market values have more influence than smaller companies with smaller market values. Today, less than 1% of NASDAQ companies represent more than 50% of the weighting. Of that big 1%, each is a technology stock.
This disparity is perhaps best illustrated by the performance of the index in 1999 when the NASDAQ rose an astonishing 86%, even though over half the stocks in the index were down for the year. The lesson here is that when the NASDAQ surges or dips sharply, it’s usually a result of only a handful of companies.
How NASDAQ Securities Are Traded
Securities trading in the NASDAQ system is based on “market makers” activities. Market makers are NASD member firms that act as “dealers,” i.e., they own securities inventories which they can sell to or buy from the public. At this time there are over 400 market makers in the NASDAQ system, and their quotations on securities issues make the NASDAQ work.
Although the market maker system is supposed to provide more competitive pricing than exchange auctioning, it’s the market makers themselves who decide whether to buy or sell a given security at a given time. The actual trading price is also up to them.
A NASDAQ market maker quotation lists two prices for any given security — the “bid price” and the “asked price.” The bid price is the highest price the firm is willing to pay for a unit of a particular security, while the asked price is the lowest price they’re willing to sell for. It’s important to note that dealers don’t always pay the bid price or get the asked price. This is to say that bid prices and asked prices don’t define the price at which a dealer is currently buying or selling a security. Instead, they define a price range — known as the “spread” — where the actual price is negotiated between buyers and sellers.
The NASDAQ vs. Exchanges
There are some significant differences between the NASDAQ and exchange trading. For starters, instead of a few specialist dealers who use their accounts to control trading in a particular security at an exchange, the system of many market makers issuing quotations is supposed to make the NASDAQ more competitive. But while quotations are very public, the actual transaction is still negotiated in private between the dealer and the buyer or seller.
Research has shown, and many investors believe, that auction bidding still provides more immediate market impact on changes in securities prices, which results in prices that more consistently reflect actual market conditions. And while the NASD does provide some of the same regulatory functions as an exchange board, NASDAQ listings and trading aren’t as tightly controlled as they are at a major exchange.