INTERNET
The Ins And Outs Of Electronic Trading
DAT To The Future
by David Penn
Electronic trading has come a long way in the six years since the
SEC's display rules of 1997. How have individual traders continued to take
advantage of a revolution in access and transparency?
In many ways, the evolution of direct-access
trading (DAT) is a classic David and Goliath tale. While many rightly point
to the explosion in technological capability -- from PCs and the Internet
to sophisticated order-routing systems exploiting intelligent networks
-- the primary driver of the electronic revolution has been the efforts
by the oft-abused and taken-for-granted retail trader to, quite frankly,
get an even break against the powerful vested interests of Wall Street
and the broader financial world.
Doubt it? Consider this excerpt from former Securities and Exchange
Commission (SEC) chairman Arthur Levitt's book, Take On The Street:
Beyond confirming the dealer collusion that many had long suspected,
the investigation brought into sharp focus a basic flaw that had developed:
Nasdaq had become a two-tiered market. One tier, the official Nasdaq dealer
network with its wide spreads, was the sucker's market for small orders,
mostly placed by individual investors. The other tier was an ECN [electronic
communications network] called Instinet, majority-owned by Britain's Reuters
Group PLC. Because spreads were narrower on Instinet, it was the market
of choice for mutual funds and other institutional investors. But it was
off limits to individuals.
Levitt was referring to the corruption and deceit that was commonplace
among Nasdaq market-makers, a sorry state of affairs that led directly
to two of the most important SEC rules revisions of the 1990s bull market:
the limit order and quote display rules. These rules essentially forced
disclosure of best bid and ask prices for smaller orders (under 10,000
shares), regardless of whether a given market maker was trading the orders
in a private exchange, such as Reuters Group's Instinet, or a public one,
such as Nasdaq's own SelectNet or SOES (small order execution system).
At root, this revision accomplished two things: it tightened spreads, allowing
retail traders to get the best prices available and actually compete with
the market makers of the Nasdaq, and it led -- somewhat indirectly -- to
the explosive growth of ECNs as, at least initially, a kind of market maker
of last resort.
What remains fascinating about the rise of truly electronic trading
(that is, the world of direct-access trading) is that this battle between
retail traders and the very system in which they struggled to compete has
not ended.
...Continued in the March issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the March 2004
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2004, Technical Analysis, Inc.
Return to March 2004 Contents
