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The term refers to how financial markets are structured. Typically, a market can be either 'concentrated', where most, if not all, trading in a set of securities is conducted in one or two trading centers, or 'fragmented' where investors send orders to numerous trading venues that all compete with each other for order flow. A trading venue can be a physical place like the floor of the New York Stock Exchange or a virtual meeting place like Nasdaq’s electronic market for trading stocks.
There is a clear trade-off between concentrated and fragmented markets, as concentrated markets can potentially provide greater depth, higher certainty of order execution, and greater transparency in terms of pricing information. However, a concentrated market can lead to monopolistic behaviour where the exchange operator might have the incentive to raise trading costs and stifle innovation.
In contrast, a fragmented market provides the benefits of more competition for order flow and greater incentives to introduce innovative new ways to trade securities. These benefits, however, might be offset by potentially greater search costs to find sufficient liquidity, reduced transparency in security prices, and greater uncertainty of order execution.
In financial markets that are larger and more developed, the current trend has been towards more fragmented markets, as the benefits of several competing trading venues (connected via high-speed computers and communications links) appear to outweigh the advantages of a concentrated market structure.
A good example of the trend towards more fragmented markets can be seen in the proliferation of trading venues for stocks in the US, where the market shares of NYSE and Nasdaq have declined sharply as dozens of newer market operators have developed potentially cheaper and faster systems to trade NYSE- and Nasdaq-listed stocks.