Modern equities markets are complex. The good news is that there are many rules and regulations designed to protect investors and facilitate fair and efficient markets. It’s important for investors to understand market mechanics in order to make well-informed trading decisions.
The US equity markets are structured with the aim of enabling markets to operate efficiently and ensure that investor interests are protected. Understanding how the exchanges work and interact can give investors greater confidence, but also present valuable insights which can help to improve trading performance.
The more investors understand the nuances of the market structure, the more effectively they can participate in equities markets. That involves developing a better understanding of the price discovery process, determinants of spreads and quotes, intraday trading behaviour, and transaction costs.
What are the main components of equity market structure?
The main components of equity market structure are rooted in regulations by federal agencies, dynamics of various trading venues, activity of market participants and dissemination of market data. Together, these elements form an ecosystem for price discovery, order execution, and liquidity provision.
How are the markets regulated?
The two primary regulators of the US equities market are the SEC and FINRA. Together, they maintain investor confidence and market integrity by preventing fraud, monitoring trading activity, and enforcing industry rules.
- Securities and Exchange Commission (SEC) – the US federal agency responsible for enforcing securities laws, protecting investors, and ensuring fair and efficient markets. The SEC oversees exchanges, broker-dealers, and investment advisors.
- Financial Industry Regulatory Authority (FINRA) – a self-regulatory organisation that regulates broker-dealers. FINRA enforces compliance with SEC rules, conducts examinations, and handles licensing and arbitration.
In addition, each listing exchange has its own set of rules, approved by the SEC, that provide transparency into their operations and govern the companies that participate in the public markets.
Tip: Check that your broker is regulated by a reputable authority such as the SEC or FINRA.
What are some key regulations governing today’s markets?
There are three key regulations governing today’s markets: the Unfair Trade Practices Act (UTP Act), Regulation NMS (Reg NMS), and the Order Protection Rule.
- UTP Act – In 1994, the SEC amended the Exchange Act to introduce Unlisted Trading Privileges (UTP) under the UTP Act. UTP allows stocks to be traded on any exchange regardless of where a security is listed.
- Reg NMS – Enacted in 2007, this rule governs how equity markets function including fair access to real-time consolidated quote data and increased transparency.
- Order Protection Rule – Implemented as part of Reg NMS, ensures trades are executed at the best available price.
Does all trading happen on the regulated exchanges?
In the capital markets ecosystem, exchanges are not the only place a trade can be matched. Across all listed US securities, approximately 60% of all shares are matched through one of the 17 regulated exchanges.
Off-exchange trading activity can occur on Alternative Trading Systems (ATSs), single dealer platforms or other over-the-counter (OTC) brokers and systems.
Transactions which are carried out off-exchange are held to similar regulations and reporting standards as transactions originating from an exchange through Reg ATS. Reporting for trades executed off-exchange is done via Trade Reporting Facilities (TRFs). While some aspects of the reporting protocols of the trading venues are similar, there are also differences between them which include:
| Definition | Examples | |
|---|---|---|
| Exchange | Regulated venues where securities are listed and traded. They are required to display quotes and trade information transparently in order to promote price discovery. | Nasdaq®, NYSE |
| ATS | Private platforms that match buy and sell orders. They are differentiated by the mechanics and methodology of order execution. | Liquidnet, ITG Postit, TMX Alpha X |
| Dark Pool | A type of ATS that trades securities without displaying quotes publicly. They are used primarily by institutions to minimise the market impact of executing large block orders. | Goldman Sachs Sigma X, CitiMatch |
| OTC | A decentralised marketplace where securities not listed on major exchanges like the NYSE or Nasdaq are traded directly between parties, typically through a network of broker-dealers. | OTC Markets Group |
Who participates in the equities markets?
The markets are an ecosystem with a diverse network of participants, each with their own specialised role to play in buying, selling and valuing stocks.
In addition to individual investors, owners of stocks include mutual funds, hedge funds, banks, market makers, arbitrageurs, family offices, pension funds, and foreign investors who hold US stocks for investment, risk management or trading purposes.
Although each of these market participants has different objectives, they all play a critical role in keeping markets efficient and liquid.
What is the tape?
The tape is the official record of trade executions across the market and are disseminated by market data feeds. The “tape” is a term tied to how stocks traded in the past, when trades were literally printed onto ticker tape.
Even in modern electronic markets, there are still three “tapes” that publish trades and prices.
- Tape A is for all NYSE listings
- Tape B is for all other exchanges, including the Cboe exchanges and NYSE Arca (which predominantly list ETFs) as well as NYSE American (which typically lists small companies)
- Tape C is for all Nasdaq listings
It’s important to reiterate it is the listing venue, not where the trade is executed, that determines which tape the trade is reported to.
Final Thoughts
The simple purpose of equities markets is to join those who need capital with those who are looking to invest. Market structure continues to evolve and modernise with advanced technology and global participation and are designed and regulated with the best interest of investors in mind.
To learn more about how to invest in US equities, check out the eToro Academy.
eToro is a multi-asset investment platform. The value of your investments may go up or down. Your capital is at risk.
Quiz
FAQs
- What is market structure, and why does it matter to investors?
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Market structure refers to the way trading is organised in the equities market, including the exchanges, trading venues, rules, and systems that match buy and sell orders. A well-structured market helps to ensure fair pricing, efficient trade execution, and transparency, which ultimately benefits all investors.
- What’s the difference between an exchange and an ATS?
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An exchange is a public venue (like the NYSE or Nasdaq) where securities are openly traded with visible quotes. An ATS is a private platform that also matches buy and sell orders, but operates under different rules with less transparency pre-trade to the market.
- Why are there different “tapes” in the stock market?
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“Tapes” are data feeds that report trade activity based on where a stock is listed, not where it is traded. They help market participants to track trade volume and price activity across different listings. Trade volume reporting is an important analysis tool because it is an early signal that investor interest in a stock is increasing or decreasing.
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