Financial exchanges rely on distinct trading mechanisms to connect buyers with sellers. In a quote driven market, professional dealers continuously post both bid and ask rates for the public. You do not have to wait for another retail investor to take the other side of your trade. Licensed market makers use their inventory to buy your shares or sell you securities on demand.
Key Takeaways
- A quote driven market is a market structure where dealers or market makers continuously provide bid and ask prices and act as the counterparty to every trade.
- The bid price shows the amount at which the market maker is prepared to purchase; the ask price reveals the level at which it is ready to sell.
- You execute buy or sell orders directly against dealer inventory, so you don't have to wait for another investor.
- In India, specific market segments use market making arrangements; NSE’s regular equity market follows an order driven trading system.
What Is a Quote Driven Market?
A quote driven market is where designated dealers or market makers provide prices for buying or selling a security. Rather than relying solely on matching two independent investor orders, the market maker commits to transacting at the quoted price and quantity, always subject to applicable rules.
These two prices are known as the bid and the ask, where the bid represents the price the market maker offers to purchase the security. The ask, sometimes called the offer price, is the level at which the market maker is willing to sell it.
Quote driven systems are typically used in less liquid markets or specific segments where continuous liquidity support is needed, rather than in high-volume, highly liquid markets where order driven systems already work well on their own.
Consider a market maker quoting a stock at ₹98 bid and ₹100 ask. A seller may transact at ₹98; a buyer may transact at ₹100, assuming the quoted size and trading conditions permit. The bid-ask spread here is ₹2 (₹100 minus ₹98), which the market maker earns as compensation for standing ready to buy and sell. This activity also involves inventory, price, and execution risks.
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How Does a Quote Driven Market Work?
The mechanism becomes easier to understand when you break it into four steps: the market maker publishes a two-way quote, an investor places an order against that quote, the trade executes if conditions are met, and the market maker adjusts its quote based on the resulting change in inventory and market conditions.
Bid and Ask Prices
Market makers quote two-way prices. The bid represents their buying price. The ask represents their selling price. The spread between these quotes compensates the market maker for providing liquidity and for bearing inventory and market risk. A narrower spread reduces the immediate price gap for an investor switching between buy and sell.
Order Execution
Suppose a maker quotes ₹245 bid and ₹250 ask. A seller can execute against the bid. A buyer can transact against the ask if the quoted quantity holds. The maker later updates its quotes as market conditions or inventory changes.
Role of Market Makers
Low volume stocks avoid freezing because market makers step in. For example, the NSE SME Emerge platform operates a hybrid system. It uses a standard electronic order book, but SEBI mandates that a designated market maker must continuously inject buy and sell orders. This ensures retail investors always have an immediate counterparty available..
Advantages of Quote Driven Markets
Trading through dealer quotes provides clear structural benefits:
- Market makers are obligated to keep quoting buy and sell prices, which keeps the market from drying up even when trading activity is thin. This is the core liquidity advantage of the structure.
- Because a dealer is always the counterparty, investors get faster trade execution, especially in securities where a matching investor order might otherwise take a long time to arrive.
- Investors can see the bid and ask before placing a trade, which makes execution more predictable.
- Where multiple market makers operate in a security, they may compete by offering more attractive quotes within the applicable framework, and that competition can improve pricing.
Limitations of Quote Driven Markets
Traders should note specific drawbacks in quote driven systems:
- Dealers adjust the difference between the buy price and the sell price to protect themselves. This spread directly acts as a transaction cost for every investor.
- Market liquidity depends entirely on whether dealers choose to remain active. If market makers pull back their quotes during sharp corrections, trading slows down noticeably.
- While providing quotes, market makers also manage inventory and market risk. Their quoted prices can therefore reflect these risks that may contribute to the bid-ask spread.
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Quote Driven Market vs Order Driven Market
The two structures differ mainly in how trading prices and counterparties are provided.
| Aspect | Quote Driven Market | Order Driven Market |
| Main participant | Market makers or dealers supply the quotes. | Buyers and sellers submit their own orders. |
| Price display | The market maker displays bid and ask quotes. | The visible order book is formed by all incoming orders. |
| Price discovery | Dealer quotes and broader market conditions influence the price. | The order book's supply and demand dynamics primarily drive price discovery. |
| Liquidity | Market maker obligations support liquidity. | The availability of buy and sell orders determines liquidity. |
| Execution | An investor transacts against an eligible quote from the dealer. | The exchange's rules match orders to execute trades. |
| Transparency | All market participants see quoted prices | The order book reveals greater depth and broader market information. |
In practice, most Indian equity investors trade primarily in order driven markets, since NSE and BSE's mainboard segments follow this structure. Quote driven elements show up mainly in specialised or less liquid segments, such as SME platforms, where continuous dealer support is needed to keep trading active.
Example of a Quote Driven Market
For example, a registered market maker quotes a bid price of ₹ 145 and an ask price of ₹150 for an SME security. The quoted quantity stands at 500 shares.
- An investor who wants to sell 300 shares can do so against that bid, provided the quote remains available, and the order meets all applicable conditions.
- Another investor may buy 200 shares at the ask.
Say the market maker's own cost for the shares it holds is close to the ₹145 bid. When it later sells shares to the buyer at the ₹150 ask, it captures the ₹5 spread (₹150 minus ₹145) as compensation for holding inventory and standing ready to trade on both sides.
In both cases, the market maker acts as the ready counterparty on either side. NSE's SME framework requires market makers to provide two-way quotes and specifies minimum depth and presence requirements.
Also Read About:Types of stock trading
Conclusion
Quote driven markets facilitate trading because dealers or market makers provide readily available bid and ask prices. This liquidity support makes it easier for investors to find a counterparty for eligible trades. India uses such market making arrangements in specific segments, while its regular NSE equity market follows an order driven system.
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