What is a crossed market?

The crossed market definition explains it as an event where a bid price for a specific asset is higher than the ask price. The situation is also referred to as ‘backwardation’, which is when the prices on the futures market are below the spot prices.

The crossed market is a temporary event. If it happens, an arbitrageur can make a quick profit. This market is considered abnormal in comparison to normal market environments in which the ask price is higher than the bid price.

According to a research paper by Andriy Shkilko, Bonnie Van Ness and Robert Van Ness entitled Locked and crossed markets on NASDAQ and the NYSE, “Locks and crosses are frequent fleeting events that usually accompany significant price changes.

“Non-positive NBBOs [national best bid and offer quotes] arise because of (i) simultaneous and (ii) tardy quote updates, (iii) electronically unreachable quotes, (iv) reluctance to trade against autoquotes, (v) order transit considerations, and (vi) ECN [electronic communications networks] liquidity attraction efforts.

“Most locks and crosses result from competitive trading practices in contemporary fragmented markets.”

Crossed market explained

What does a crossed market mean? Crossed market trading is an uncommon event. It could develop due to other anticipated events during the trading day, such as a large influx of orders. When this happens, an extremely high volume of orders is entered before the market officially opens. However, crossed markets can also happen during open market hours.

Crossed markets are likely to happen in either extremely fast trading conditions in volatile markets, or extremely slow movement in illiquid markets. Both of these situations can result in situations where the bid prices are temporarily higher than the ask prices.

In a very fast trading situation, the crossed market means a panic trading, which causes prices to plummet. As a result, computer algorithms take over and begin automated purchasing, which results in rapid price swings. The bid price may be held unnaturally above the ask price during these situations.

According to the Locked and crossed markets on NASDAQ and the NYSE report, there are several factors commonly blamed for causing non-positive spreads:

“The first is faulty connectivity among market centres. Since both the NYSE [New York Stock Exchange] and NASDAQ have multiple venues quoting their securities, quotations may, at times, be posted without proper coordination, and lock or cross the market.

“Indeed, the multiplicity of quote and trade sources may become a serious impediment to efficient market operations. Suppose two exchanges post quotes simultaneously or within a very short time period. If one of them, unintentionally, posts a bid that is equal to (higher than) the offer of the other, the inter-market locks (crosses).

“In a similar fashion, if market makers on one exchange are not aware of the quotes posted on the other exchange due to the invisibility of the latter, the NBBO spread may be unintentionally locked or crossed.”

Other extraordinary events that can extend the crossed-market period

Unless there are extraordinary events in the wider economy that continue to fuel the phenomenon, it is very likely that the spread between the bid and ask price will continue to shrink during the market's opening hours, in which case it will gradually return to normal market conditions.

Natural disasters, hostile takeovers of companies or political upheavals that overthrow a government are examples of extraordinary events that could have a direct impact on the specific securities in the market place and may extend the crossed-market period.

A crossed-market situation can also be artificially created by purposefully placing bid prices that exceed the ask or offer prices. This activity is considered unethical in the majority of markets, and is even deemed illegal by some. This type of strategy is disliked because it allows a small number of market participants to take advantage of the situation, and possibly continue to drive it for an extended period of time by making purchases and sales that would not be possible in a normal market environment.

However, as the research by Shkilko, et al. concluded: “Locked and crossed markets are the result of poor coordination and/or quote inaccessibility among market centres, and are mostly unintentional.”