What is the National Best Bid and Offer (NBBO)?
The National Best Bid and Offer (NBBO) represents the highest bid price and lowest ask (offer) price for a security across all participating exchanges or trading venues. Essentially, the NBBO defines the most favorable composite bid-ask spread available.
The Securities Exchange Commission (SEC) enforces [Regulation NMS], which mandates brokers to ensure the most advantageous ask and bid prices when buying and selling securities for clients, guaranteeing at least the NBBO quoted price at the time of each trade.
Key Takeaways
- The NBBO displays the best available (i.e., lowest) ask price and best available (i.e., highest) bid price for customers via multiple exchanges.
- SEC Regulation NMS ensures brokers guarantee at least the NBBO quoted prices at the time of a trade.
- NBBO calculations and distributions are managed by Security Information Processors (SIP).
- While NBBO ensures optimal trade prices, it may not always reflect the latest market data, affecting expected trade matches.
Understanding the National Best Bid and Offer (NBBO)
SIPs calculate and disseminate the NBBO as part of the National Market System Plan (NMSP), processing security prices across markets. Two primary SIPs manage this task:
- Consolidated Quotation System (CQS): Manages NBBO for New York Stock Exchange (NYSE), NY-ARCA, and NY-MKT-listed securities.
- Unlisted Trading Privileges (UTP) Quote Data Feed: Manages NBBO for Nasdaq-listed securities.
The NBBO fluctuates throughout the trading day to reflect the top bids and offers from various exchanges and market makers. The lowest ask and highest bid might not originate from a single exchange, distinguishing them simply as the ‘best bid and offer.’ Dark pools and alternative trading systems often don’t reflect in these results due to their operation’s opaque nature.
Traders with large orders utilize an exchange’s or market maker’s depth of book data or Level II market maker screens to explore other potential bid and ask prices for executing their trades.
Advantages and Disadvantages of the NBBO
Advantages:
- The NBBO ensures optimal trade prices for all investors through their broker without needing to manually aggregate quotes from multiple exchanges before ordering. This convenience levels the playing field for retail traders.
Disadvantages:
- NBBO may not reliably present up-to-date data, potentially leading to execution prices differing from investor expectations. This is particularly concerning for high-frequency traders (HFT) who bank on minuscule price shifts due to high volumes.
- Enforcing Regulation NMS is challenging due to rapid trading velocities and a lack of recorded NBBO prices, complicating validation whether a trade was executed at the NBBO price.
- Not all prices are displayed in NBBO since dark pools and less transparent trading systems often hide bid/ask prices.
NBBO and High-Frequency Trading (HFT)
HFT firms invest in specialized infrastructures to connect directly to exchanges and process orders faster than other brokerages, sidestepping reliance on SIP data for bid/offer calculations and profiting from publication gaps. Research indicates HFT entities can front-run others, exploiting latency for gain.
A 2013 University of Michigan study found that traders benefitted by as much as $21 billion by exploiting these discrepancies: “By anticipating future NBBO, HFT algorithms capitalize on cross-market disparities before public pricing adjusts, lining up sure pocket profits. This creates a race amongst traders for faster computing and predicting NBBO fluctuations.
Example of the NBBO
Consider a broker presenting the following sell orders for stock ABC:
- 200 shares for $1,000
- 300 shares for $1,500
- 100 shares for $1,800
- 350 shares for $1,600
Simultaneously, the following bid prices for stock ABC are available:
- 100 shares for $900
- 200 shares for $800
- 150 shares for $950
The NBBO for stock ABC becomes $950/$1,000 because those are the best bid/offer prices available to traders within the observed quotes.
Related Terms: Regulation NMS, best bid, best ask, market makers, high-frequency trading.
References
- The Securities Exchange Commission. “Regulation NMS”.
- Strategic Reasoning Group. “Latency Arbitrage, Market Fragmentation, and Efficiency: A Two-Market Model”.
