How Locked Markets Can Disrupt Price Formation and Trading
Summary
The document explains why a locked market—where the best displayed bid equals the best displayed ask—can be viewed as a market quality problem. It describes two effects: a lock can stall the process of price discovery, and it can make it harder for investors to trade, adding friction and transaction costs. Allowing buyers and sellers to interact helps supply and demand continue to shape prices.
The discussion is conceptual rather than empirical. It points readers toward the SEC’s Reg NMS adopting release for the regulator’s rationale, but does not summarize specific provisions of Rule 610 or establish how often locks occur or what costs they cause. It also does not directly resolve the question of why a market maker might pay a taker fee to trade against a locking order, or how that differs from encountering a better-priced quote in an unlocked market.
Key ideas
- A locked market has a displayed bid equal to the displayed ask.
- A lock can interrupt price formation by preventing displayed prices from moving naturally.
- Trading impediments can add friction and transaction costs for investors.
- The SEC’s Reg NMS adopting release is a primary source for the rationale behind the rules.
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Full text
# Locked or Crossed Markets # Locked or Crossed Markets I don't understand why Rule 610 from Reg NMS was introduced: what was the problem with locked markets? I have read that one of the issues is that it forced a market maker (say, from Nasdaq) who needed to buy a stock (and who had the obligation to provide the best possible price for a client) to go and "pick" the locking Sell Limit Order from the locking venue (say, Instinet) and pay the taker's fee. However, this would have been true for every time in which a competing ECN was posting an ask quote that was lower than the one posted by the market maker and not only when the markets were locked... Am I missing something? ## Answer by Bikenfly (score 2) https://quant.stackexchange.com/a/14842 The adopting release of Reg NMS http://www.sec.gov/rules/final/34-51808.pdf discusses the problem(s) they were looking to solve. That will provide the SEC's thought process. ## Answer by lehalle (score 2) https://quant.stackexchange.com/a/15599 Having locked markets is bad in the sense - it freezes the price formation process. Ideally we would like to have a price on as much instruments as possible so that we know their value. - it prevent investors to buy (or sell) it and thus adds frictions, transaction costs, etc. We would like to enable investors to buy or sell when they need/want, to let the offer and demand dynamic game to take place.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.