The Over-The-Counter Market

In contrast to the organized security exchanges, the over-the-counter market is a nebulous, intangible organization. An explanation of the term “over-the-counter” will help clarify exactly what this market is. As noted above, the exchanges operate as auction markets-buy and sell orders come in more or less simultaneously, and exchange members match these orders. If a stock is traded less frequently, perhaps because it is the stock of a new or a small firm, few buy and sell orders come in and matching them within a reasonable length of time would be difficult. To avoid this problem, some brokerage firms maintain an inventory of such stocks-they buy when individual investors want to sell and sell when investors want to buy. At one time, the inventory of securities was kept in a safe and the stocks, when bought and sold, were literally passed over the counter.

Today, the over-the-counter market is defined to include all facilities that are needed to conduct security transactions not conducted on the organized exchanges. These facilities consist of (1) the relatively few dealers who hold inventories of over-the-counter securities and who are said to “make a market” in these securities: (2) the thousands of brokers who act as agents in bringing the dealers together with investors; and (3) the computers, terminals, and electronic networks that provide a communications link between dealers and brokers. The dealers who make a market in a particular stock continuously quote a price at which they are willing to buy the stock (the bid price) and a price at which they will sell shares (the asked price). Each dealer’s prices, which are adjusted as supply and demand conditions change, can be read off computer screens all across the country. The spread between bid and asked prices represents the dealer’s markup or profit.

Brokers and dealers who make up the over-the-counter market are members of a self-regulating body known as the National Association of Securities Dealers (NASD), which licenses brokers and oversees trading practices. The computerized trading network used by NASD is known as the NASD Automated Quotation System (NASDAQ), and the wall Street journal and other newspapers provide information on NASDAQ transactions.

In terms of numbers of issues, the majority of stocks are traded over the counter, and trading volume is greater on NASDAQ stocks than on the NYSE. However, because the stocks of most large companies are listed on the exchanges, more than half on the dollar volume of stock trading takes place on the exchanges. In recent years, many large companies-including Microsoft, Intel, MCI, and Apple-have elected to remain NASDAQ stocks, so the over-the-counter market is growing faster than the exchanges.