Thirdmarket

Key Takeaways

• The third market involves trading exchange-listed securities via broker-dealers and institutional investors outside traditional exchanges.
• Institutional investors favor the third market to execute large trades without affecting stock prices on main exchanges.
• Avoiding traditional exchanges can lead to cost savings, but requires understanding risks and changing market conditions.
• Third-market makers provide liquidity, ensuring trades can occur even when immediate buyers or sellers are unavailable.

What Is the Third Market?

The third market allows non-exchange member broker-dealers and institutional investors to trade stocks that are listed on traditional exchanges, such as the New York Stock Exchange (NYSE), outside of these exchanges. Securities that are typically bought and sold on major stock exchanges are instead traded over the counter, offering benefits like reduced broker fees.

The third market is essential for institutional investors looking for greater flexibility and potentially lower trading costs. We'll explain how the third market operates, the type of investors who involved, and the benefits it can offer.

How the Third Market Works

When hearing news about the financial markets, most investors have heard of the primary and secondary markets, but there is a third market as well. The primary market describes the issuance of new securities, such as an IPO or initial public offering of a new stock or security. The secondary market is traditionally where stocks and securities are traded, which is the market most investors are familiar with and execute their trades.

The third market is a marketplace or venue in which brokers and institutional investors, such as fund managers, can trade securities that are exchange-listed and are usually traded on a formal exchange such as the NYSE. When these exchange-listed securities and shares are traded in the third market, investors bypass the secondary market and the exchanges.

Before selling exchange-listed securities to a non-member in a third market transaction, a member firm must fill all limit orders on the specialist's book at the same price or higher. Typical institutional investors who take part in the third market include investment firms and pension plans. The third market brings together large investors willing and able to purchase and sell their own securities holdings for cash and immediate delivery. Securities can be purchased at lower prices in the third market because of the absence of broker's commissions.

Third-party trading systems bypass traditional brokers and allow large and possibly rival institutions' block orders to "cross" with each other. Anonymity rules prevent either side from knowing the identity of the counter-party. There are additional rules and logic built into flow management interfaces, but there is some information that cannot be shared with the public, which gives the transaction sufficient anonymity.

Fast Fact

Third-market trading began in the 1960s with firms such as Jefferies & Company, though today there are a number of brokerage firms focused on third-market trading.

The Role of Third Market Makers in Trading

Third-market makers add liquidity to financial markets by facilitating buy and sell orders even if there isn't a buyer or seller immediately available for the other side of the transaction. Third-market makers make a profit from their roles as intermediaries by buying low and selling high. They also place trades for brokers on exchanges of which that broker is not a member.

A third-market maker might act as a buyer when an investor wants to sell but just wants to make a small, short-term profit from buying a security at a favorable price and selling it to another investor at a higher price. Third-market makers sometimes pay brokers a small fee of a cent or two per share to direct orders their way. Sometimes brokers and third-market makers are one and the same.

Fast Fact

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.

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