Where the Magic Happens: Markets and Rules

In the second half of Chapter 3, Larry Harris dives into the different types of markets and the rules that keep them from turning into the Wild West.

The Different Flavors of Stock Markets

Not all stock markets are created equal. In the US, we have three main types:

• Primary Listing Markets: Like the NYSE or Nasdaq. This is the “home” of the stock.
• Regional Exchanges: Places like the Chicago or Philadelphia Stock Exchange. They often trade the same stocks as the NYSE but with different rules or fees.
• The Third and Fourth Markets: This is “off-exchange” trading. The Third Market is when dealers trade listed stocks away from the exchange. The Fourth Market is when big institutions trade directly with each other using electronic systems (ATSs).

A Gotcha: How Volume is Counted

Here’s something that trips up a lot of people: Volume numbers are often inflated.

On the NYSE, if a buyer and seller trade 100 shares, that’s 100 shares of volume. But on Nasdaq (a dealer market), if a dealer buys 100 from a seller and then sells 100 to a buyer, the market might report 200 shares of volume! Some systems even triple-count. Always check if a market is “TSV” (counts only system trades) or “REV” (counts everything it supervises).

The Regulators: Who’s the Boss?

In the US, two big agencies run the show, and they don’t always get along:

• SEC (Securities and Exchange Commission): They handle stocks, bonds, and options.
• CFTC (Commodity Futures Trading Commission): They handle commodities and futures.

Because some products (like stock index futures) look like both a stock and a commodity, these two agencies have had legendary “turf wars.” The Shad-Johnson Accord of 1982 was basically a peace treaty to decide who gets to regulate what.

SROs: Cops on the Beat

Then there are SROs (Self-Regulatory Organizations). These are private groups like FINRA (formerly NASD) or the exchanges themselves. They write the “house rules.” If you want to be a broker, you have to play by their rules, or they’ll kick you out of the club.

Unintended Consequences

Regulation is a delicate balance. If you over-regulate or tax trades too much, the liquidity just leaves. Harris points to Brazil, which tried to tax all financial transactions in 1997. The result? Everyone just started trading Brazilian stocks in New York as ADRs, and the local Brazilian market withered.

Wrapping Up the Industry

The big takeaway from Chapter 3 is that the trading industry is a massive, complex ecosystem of buyers, sellers, facilitators, and regulators. It’s built on a foundation of trust, technology, and very specific rules.

Next time, we’re going to get technical and look at Orders—the basic building blocks of every trading strategy.

Next Post: Orders and Their Properties