What it means
NMS stands for national market system, and the idea behind it is that shares of the same company trade on many venues at once. Without common rules, an investor could get a worse price simply because the order happened to go to the wrong place.
Regulation NMS creates shared standards so that the best displayed prices are respected across the market. The headline requirement is the order protection rule, which discourages a trade-through.
A trade-through happens when an order is executed at a price that is worse than a better, immediately accessible quotation displayed on another venue. Venues must therefore have procedures to avoid such trade-throughs or to route the order to the better price.
The access rule limits the fees that a venue can charge for accessing its displayed quotes and requires fair, non-discriminatory access to them. The fee cap is set per share by the rule.
This keeps one venue from using high fees to make its quotes unattractive to others, and it makes the quoted price a closer match to the all-in cost. The sub-penny rule says that venues generally may not display or accept quotes in increments smaller than one cent for stocks priced at $1 or more.
Tick sizes this large make prices easier to read and make it harder to jump the queue with a tiny price improvement. There are also market data rules that govern how quotes and trade information are shared and how revenue is allocated.
For a business reader the importance is practical. The structure shapes execution quality, the fees that brokers pay and the way high-speed traders compete with each other.
Companies thinking about their own stock's trading, or investors watching for hidden costs, should know these rules set the plumbing of the whole US equity market. One nuance is that the order protection rule protects only quotations that are automated and immediately accessible, not every price displayed anywhere.
Manual quotes, for example, are generally not protected. Reading the detail matters when judging whether a given trade broke the rule.
In practice
Real-world examples.
Example
A retail investor places an order to buy 500 shares through an online broker. The broker's routing system checks all protected quotes and sends the order to the venue with the lowest offer. The investor sees a fill at the best displayed price.
Example
A large pension fund trades through an algorithm that splits an order across several venues. The fund's trading desk reviews a report that shows each fill against the best quote at that moment, to confirm that the rule was respected.
Example
An exchange operator designs its trading system so that quotes are updated automatically and reflect the best price from other venues. Its compliance team documents the procedures needed to prevent trade-throughs and tests them regularly.
Formula
Calculation
Cost of a trade-through = (price paid - best available price) x number of shares
An investor buys 1,000 shares. One venue displays an offer at $50.00 that is immediately accessible. The order is executed at another venue at $50.02. Cost of the trade-through = ($50.02 - $50.00) x 1,000 = $0.02 x 1,000 = $20. Under the rule the order should have been routed to the $50.00 offer or the venue should have had a way to match it.Case study
Seen in the real world.
Quillfeather Securities is an illustrative, fictional broker that handles orders for retail investors. During a quarterly review, its best-execution committee found that several thousand orders had been routed to a venue that paid the broker a small rebate, even though other venues sometimes displayed slightly better prices.
The firm adjusted its router to put the best displayed price first and to treat rebates only as a tie-breaker. It also began sending customers a plain-English summary of execution quality each quarter. The illustrative lesson is that a rule about price protection also forces a broker to examine its own incentives, and good routing is a matter of governance as much as technology.
Quillfeather also began testing its routing decisions against the best displayed quotes at the time of each order. The tests showed that nearly all orders now received the best available price, and the few exceptions were explained by quotes that were not immediately accessible.
Watch out
Common mistakes.
- Thinking the rule guarantees every investor the best price in the world, when it protects only displayed, automated and accessible quotations.
- Assuming all venues are the same, when different venues charge different fees and offer different speeds that affect execution.
- Believing the rule covers all securities, when it applies mainly to listed equities and options in the national market system.
Questions
People also ask.
Does Regulation NMS set the price a stock trades at?
No, it sets the rules for how orders are routed and quotes are displayed, while the price is still determined by supply and demand.
What is a trade-through?
It is an execution at a price worse than a protected quote that was displayed on another venue at the time.
Why does the sub-penny rule exist?
It prevents tiny price increments from being used to jump ahead of other orders and keeps quoted prices simple to compare.
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